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What Can Be Done With Student Loans to Help Homebuyers?

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.

It’s About Your Debt-to-Income Ratio

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%.

How to Lower Your DTI - Including Student Loan Payments

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):

  • Make larger monthly payments to lower your overall debt. You might focus on your smaller debts to eliminate them completely. Once a debt is gone, there is no longer a minimum monthly payment. DTI is about your minimum monthly payments.
  • Work hardest on debt with the highest ‘bill-to-balance’ ratio. For example, you might owe $100 on Credit Card A and $50 on Credit Card B. Card A’s monthly payment is $20 and Card B’s is $25. You want to target Card B first because your monthly payment is 50% of its balance and Card A’s monthly payment only makes up 20%. As a result, paying off the $50 you owe on Card B will have a larger impact on your DTI than paying off the $100 you owe on Card A.
  • Don’t’ take on additional debt. That means stopping all credit card charges. A place to start is looking at stopping automatic charges to your credit cards, especially if you don’t always pay them off in full every month. Instead of automated payments, force yourself to make the payments manually. This increases your awareness of how you are spending your money.
  • If you are planning to make a large purchase using credit, postpone it as long as possible and save as much cash as you can to apply towards the purchase. The lower debt that you do take on will have less impact on your DTI.
  • Make a habit of recalculating your DTI monthly. Seeing your DTI continue to improve can help you stay motivated to keep your debt manageable.
  • Consider an extra job or another source of income (ask for a pay raise). Additional income is the other part of the equation for lowering your DTI.

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.

Photo by Rochelle Nicole on Unsplash

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 askbrian@realtybiznews.com.

Brian Kline

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