A study by American Student Assistance found that 55% of student loan holders said their debt is causing them to put off homeownership. That’s discouraging when you consider the long streak we are experiencing for historically low-interest rates. With low-interest rates and low or no-down payment programs available, people saddled with large student debt should be doing everything they can to take advantage of these opportunities.
Those student loans have no more effect on your ability to qualify for a mortgage than any other type of debt that you might have. Student loans count the same as a car loan or credit card. Of course, lenders look closely at your credit score but just as important is your debt-to-income ratio (DTI). There are positive steps you can take to improve how lenders view both. Here we look at lowering your DTI.
DTI compares how much you owe each month to how much you earn. Specifically, it’s the percentage of your gross monthly income (before taxes) that goes towards payments for rent, credit cards, or other debt. There are many online calculators to help you calculate your DTI.
Lenders have different acceptable DTI levels with different factors determining what they accept. Your credit score and cash reserves are two important determining factors for an acceptable DTI. The higher your DTI, the higher the mortgage interest rate that you’ll be charged. A higher interest rate makes qualifying for a mortgage more difficult because your monthly mortgage payment will be higher. So, interest rate, credit score, and DTI are all working together to determine if you qualify for a mortgage. Since a higher credit score allows for a higher DTI, managing your debt is the key to a first mortgage.
Most first time buyers look for government-backed loans with low or no-down payment requirements. The current Federal Housing Authority DTI requirement ranges from 31% - 40% depending upon the borrower’s credit score and cash reserves. Generally, you want to target a DTI at-or-below 36%.
Because interest rates are expected to remain low for many months to come and even as long as the next couple of years, you have time to lower your DTI to still obtain a historically low mortgage rate. This probably won’t be easy but here is where you should begin (these also improve your credit score):
When it comes to your student debt, it’s the amount you pay each month that matters. It’s not the overall amount of debt you owe. Federal student loans offer some flexibility about the amount you pay each month. For example, you could try switching your student loan repayment plan from standard to graduated or extended to see whether the lower payment reduces your debt-to-income ratio. Another way is to request lengthening your payback period to reduce the amount you owe each month.
There are a number of mortgages that work well for borrowers with student debt, including the FHA loan, the Fannie Mae HomeReady mortgage, and the VA loan. These programs may allow 100% financing, low or no-down payments, and more.
Please comment with your strategies for how first time buyers with student debt can lower their DTI.
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 [email protected].