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One of the most important factors that lenders consider when evaluating you for a mortgage is your debt, including any student loans you must pay back.
“Student loans can affect a consumer’s ability to get a mortgage because they are a liability that factors into your debt-to-income ratio,” says Adam Selita, CEO and co-founder of The Debt Relief Company in New York City.
If your debt-to-income ratio — all of your monthly debts payments divided by your gross monthly income — is too high, it can be difficult to qualify for a mortgage.
“Your DTI is a key qualifier on mortgage loans nationwide because it’s a measure of risk and an ability to repay your loan,” explains Chris Kemp, Vice President of Sales, Flagstar Bank Home Lending in Michigan. “A good DTI to get approved for is 36%.” Always check with your lender, but “the lower the number the better for you,” he says.
Katherine Ryckman, 29, and her husband, Michael, kept this in mind as they worked through the home buying process last year.
“I had almost $14,000 in undergraduate student loan debt,” says Katherine, a technical writer, who got married in July 2019. “My husband came into our marriage without any student loan debt.”
The Hawaii-based couple stayed with his parents for a few months after they wed to pay off “wedding debt and credit cards,” she says. And her student loans?
“Our plan was to start paying off my student loan debt after we moved into our new townhouse in February, but during the home-buying process, we made on-time consistent payments.” Now that they’re settled into their new home. they’ve been slowly ticking off the debt, and have a little less than $9,000 to pay off.
While you don’t have to be completely debt-free prior to purchasing, consider these tips when buying a house with student loans in tow.
Get your finances straight
It’s common for borrowers to have student loans and other debts going into the
home-buying process, so don’t let that deter you. Well before you hire a realtor or start looking at houses, prepare financially with these strategies from Kemp:
• Be sure all of your monthly payments are made on time, and “never be more than 30 days late,” says Kemp.
• “Provide evidence of a timely payment history on your debts,” he says. Keep a copy of your current credit report on hand and ask creditors for a letter that lists payments made and confirms they were paid on time.
• Finally, Kemp suggests scheduling a mortgage analysis with a lender to assess your creditworthiness and ability to qualify.
Understand your credit report
Student loans can impact a consumer’s creditworthiness via reported payment history and length of time accounts have been established, says Selita. “Newer student loans will be worse for your credit,” he says, “while those that have established for some time and are nearly paid off will have a positive impact on your credit.”
Pay down debt
The Ryckmans chose to shed personal debt instead of student loan debt prior to purchasing a home. But Shang Saavedra, a personal finance expert at SaveMyCents.com, says, “it’s a good idea to pay down student loan debt, especially if doing so qualifies you for a better mortgage.”
Saavedra recommends pausing expensive purchases, taking on roommates, or cooking more at home, then applying the extra cash to the “student loans with the highest interest rate or those with the largest balances.”
Eliminate some loans early
If student loans prevent you from achieving a qualifying debt-to-income ratio, try paying off some student loans early.
“The key is to pay each account in full, one by one, so that the monthly expenditure is not impacting your DTI,” says Selita. “Making minimum payments on each account is not a solution.”
Start saving the down payment
As you pay down or pay off debt, make sure to have “seasoned funds” in your account for the down payment.
“A down payment of 20% is ideal to avoid paying private mortgage insurance and to start your home purchase out with a good loan-to-value ratio of 80%,” says Selita. “This will also help you to qualify for the mortgage and keep your DTI at a favorable percentage.”
A game plan for the remaining debt
Once you purchase the home, decide how you’re going to pay off the remaining student loans.
“I recommend getting on a budget if they’re not already on one and then sticking to it initially for three months,” says homeowner Katherine. “Any extra money they can squeeze out of the budget should be thrown at their debt.”