Can my student loans affect my eligibility for a home loan?
Many factors are considered when qualifying you for a home loan and student loan debt is one of them. By now, many of you know that lenders look at your income versus your debt when calculating how much you can afford in a mortgage. The result from this calculation is what’s called your “debt-to-income ratio” or DTI. A DTI ratio is comprised of two parts, a front-end ratio and a back-end ratio. The front-end ratio, also known as the housing ratio, focuses on your gross monthly income in comparison to your projected monthly mortgage payment. You can calculate your front-end ratio by dividing your expected monthly mortgage payments by your gross monthly income (income before taxes). The back-end ratio focuses on all your debt obligations in relation to your gross monthly income. This figure is calculated by adding all of your monthly debt payments to your housing expenses, then dividing that number by your gross monthly income. Examples of expenses considered as debt and calculated into your ratios include credit cards, car loans, child support, alimony, and student loans. The maximum allowable limits on your front-end and back-end ratios vary based on the loan program you choose, however, on a typical FHA loan the standard limits are 31% front-end ratio and 43% back-end ratio as of April 2020.
Here’s where having a student loan balance can get tricky. As mentioned earlier, student loan payments are factored into your debt-to-income ratios. Those ratios have to be within a certain range to get approved for a home loan. Thus, having high student loan payments can negatively affect the amount you can qualify for in a mortgage. Furthermore, within the last few years, FHA guidelines have changed to where lenders now calculate student loan payments at 1% of the total loan balance. For example, on a student loan balance of $50,000, the lender will include a monthly payment of $500 into your calculated DTI ratios, regardless of whether you’re currently paying that amount or not. For some, the added $500 payment when compared to their income either significantly reduces the purchase price that borrower would qualify for or worst, could disqualify them for a home loan altogether.
It’s important to note that not all loan programs follow this method of calculating student loan payments when evaluating a borrower’s documents for loan approval. Conventional loans still base their numbers off what the buyer is currently paying monthly.
Fortunately, there are tons of people out there with student loans who have successfully purchased homes and they didn’t have to be millionaires to do it either. If education is making your DTI ratio too high, there are some steps you could take to help qualify.
- Pay down other debts such as credit cards, car loans, etc.
- Find ways to pay off the student loan debt faster such as picking up a small part-time gig and use the extra funds to make extra payments on your loan. There’s no penalty for pre-paying your student loans.
- Consolidate your student loans and then submit a request for what’s called an income-based repayment plan to your loan administrator. For many, being on an IBR plan significantly lowers their monthly payment. With the reduced payment, a borrower can apply for a different loan program that doesn’t weigh student loans so heavily.
- Inquire if the lender will allow higher DTI ratios for approval. For higher ratios to be approved through underwriting, a borrower will have to have other compensating factors to negate the high debt such as a higher credit score, steady employment, etc.
The main takeaway, student loans can directly affect your eligibility for a home loan. However, with proper knowledge and preparation, your dream of owning a home is closer than you think!