The situation still isn’t ideal (and probably never will be) but now is a good time for people burdened with student debt to take another look at the possibility of homeownership. Not that there are a bunch of eager sellers looking to sell because there are not.
There are reports that as the spring buying season approaches, the inventory level is at the lowest level since 2013. Still, the financial picture around student debt is looking a little better.
The truth is there has not been enough done when it comes to helping those with student debt become homeowners. But there are a few things that you want to consider. One thing to do is make sure that your student debt is structured in a way that favors you qualifying for a mortgage.
According to Consumer Reports, the average student debt is around $30,000 with a monthly payment of $330 to $400. This is based on the standard loan structure for student loans. Most students don’t consider the different ways the debt can be structured. Instead, they go with the default setting. That means you make equal monthly payments for 10 years, adding up to 120 payments. But this might be holding you back from becoming a homeowner.
In most cases, student debt affects your ability to qualify for a mortgage in two ways. First is your credit score, which is primarily driven by your payment history. Nothing has changed here. If you miss payments, your credit score will fall. Either you won’t qualify for a mortgage or you’ll have to pay a higher interest rate. But that higher interest rate can still disqualify you because it drives up your debt-to-income ratio (DTI). Your DTI is the other most influential factor when applying for a mortgage.
Interest rates are still at historic lows. That works in favor of your DTI by lowering monthly mortgage payments. The chances that you’ll ever see interest rates this low again are almost nonexistent. You want to take advantage of this opportunity because you don’t know how long low-interest rates will be around. So, work on your credit score first, while figuring out how to lower your DTI.
Once you have a credit score that qualifies for a mortgage, your DTI becomes the driving factor. Changing the structure of your student loan can be how you lower your DTI to qualify for a mortgage. You can switch plans anytime and you should re-evaluate your payment options periodically. Good times to do this are when you have a major life event, such as starting a new job, getting married, getting a promotion (or pay raise), and when trying to buy a home.
If you simply want to pay off the debt as fast as possible and pay the least amount of total interest, find the lowest interest rate available. Then just start making extra payments. There are no penalties for paying off student debt early. But this isn’t the best option for many people because it doesn’t keep them in control of their DTI… but a variation it might work. You can look at balancing the length of the loan with finding the lowest interest rate. The more years you have to repay the loan, the lower your required monthly payment will be. Your required monthly payment is what determines your DTI. You can still make extra payments to pay the debt off sooner. Having lower required payments but still making extra payments is a powerful way to be in control of your finances.
Once you qualify and close on a mortgage, you might not be able to continue making extra payments on the student debt. If so, you can switch to making the lower required payment. You’ll have made two major gains by doing this. You’ll have become a homeowner based on a lower DTI and you’ll have reduced the outstanding balance on the student loan when you did make extra payments. Reducing the outstanding loan balance means paying less total interest.
Another DTI lowering approach are the income-driven repayment plans. In 2017, Fannie Mae began allowing lenders to calculate DTI based on flexible student loan repayment plans. There are several options available. Using one of these sets your monthly student loan payment based on your income and family size. There is no guarantee that one of these plans is the magic bullet that will qualify you for a loan. However, you can research how much these options will reduce your required monthly student loan payment and then run the numbers through an online DTI calculator. If this option will work for you, you want to change your student loan plan about a year before you’ll be applying for a mortgage so that your credit report shows a history of on-time payments.
What you don’t want to do if you are trying to buy a home is enter into student loan deferments or forbearances. These signal financial hardship to lenders and will lower your chances of qualifying.
What suggestions or experience can you offer for mortgage qualification with student debts? Please leave your comments.
Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to firstname.lastname@example.org.
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