Student loans — in moderation — can help you achieve your educational and career goals. But as I’m sure you already know, they also have a downside.
Student debt can have long-lasting implications on other areas of your life as well. One of these unexpected consequences is that your student loans impact whether or not you’ll qualify for a mortgage.
Many factors determine your ability to qualify for a mortgage. But student loans, due to their balance size and long-term repayment schedules, can particularly affect the home-buying process.
Thinking about buying a home? Here’s what you need to know.
Getting a Mortgage With Student Loans
Here’s the crux of the issue: Are you able to handle a mortgage payment?
You might say “yes.” But your lender may say “no.”
Your lender is going to look at both your front-end and back-end debt-to-income ratio (DTI) to determine the amount you can afford for a mortgage loan.
A front-end ratio is also known as the housing ratio. This ratio is found by dividing your projected monthly mortgage payments by your gross monthly income (your income before taxes).
Your projected mortgage payment will include the costs of the principal, taxes, insurance, and interest payments, collectively known as PITI.
- You earn $50,000, which is $4,166 per month
- Your PITI comes to $1,200 per month
- $1,200 / $4,166 = 0.28, or a front-end ratio of 28 percent
Your lender will set the terms of the limit for conventional loans. Depending on the lender, expect a limit that ranges from 28 percent to 36 percent for the front-end ratio.
FHA loans (as of 2015) allow for a maximum of a 31 percent front-end limit.
The back-end ratio accounts for all of your debt obligations in comparison to your income. The lender will find this ratio by adding your monthly debt payments and then dividing that number by your gross monthly income.
These debt payments include the PITI on your mortgage, child support, credit card minimum payments, and — yes — student loans.
Here’s an example:
- You still earn $50,000, or $4,166 per month
- Your PITI is still $1,200 per month
- You have a small credit card balance with a $50 per month minimum payment
- You have a student loan with a $375 per month minimum payment
What’s your back-end ratio?
- Your monthly debt payments come to $1,625
- $1,625/$4,166 = 0.39, or 39 percent
Here’s the rub: Typically, conventional lenders prefer to see a back-end ratio under 36 percent. If you take out an FHA-backed loan, the highest back-end ratio you can hold is 41 percent.
In this example above, you could qualify for an FHA loan, but perhaps not a conventional loan. This illustrates how student loans (and other debt) can interfere with your ability to qualify for a mortgage.
Don’t worry, though. There are other options.
- Some lenders will allow you to hold a back-end ratio that’s as high as 50 percent if you have great credit. This is uncommon, but possible.
- If you have other loans with small balances (like the small credit card balance in the example above), wiping out this loan in its entirety could put you over the edge.
- You could also look for a less-expensive house with lower PITI.
Student Loans and Mortgage: Other Deciding Factors
How big is your down payment?
The size of your available down payment will affect your front-end ratio — the more you borrow, the higher the PITI. If you can save a 20 percent down payment, your student loans are far less likely to affect your loan process.
How high is your income?
Your income is a key factor in determining your acceptance for a loan. The concept of debt-to-income ratio (both front-end and back-end) pits two variables against each other: your debts and your earnings. This may be one of the reasons why a Zillow report shows that student loans have a negligible impact on getting a mortgage as long as you have a bachelor’s degree or higher. Sure, you have loans — but you also have a higher income.
It’s tempting to focus on debts, but if you can boost your earnings (such as negotiating for a raise), you’ll also improve your debt-to-income ratio.
How long have you had your job?
Did you spend several years of your adult life completing graduate school? The loans themselves may not affect your ability to secure a mortgage, but your employment history might.
Unfortunately, as part of the credit history portion of certifying you for a loan, certain lenders won’t accept your income numbers unless you have at least two years of employment history. (Some lenders want to see you stay the same employer for two years. Others will be satisfied if you at least stay within the same industry).
If you’re fresh out of school and into the workplace, you might not be able to secure a mortgage for a year or two.
How student loans affect the mortgage process
Student loans by themselves cannot prevent you from getting a mortgage. The effect of the student loans on your debt-to-income ratio is the key deciding factor.
When you go to a lender seeking a home loan, they are going to look at your front and back-end ratios, your credit history, your assets, and how large of a down payment you have available.
Remember, your back-end ratio considers all of your monthly debt payments. This includes your student loan payments, car payments, credit card, and personal loan payments. If you have high monthly student loan payments but no other debt, you have a decent income, and you’re looking for a reasonably-priced home, you will most likely be fine when you apply for a home loan. (If you’re not sure, however, crunch the numbers yourself.)
If, however, those debts push you past the 41 percent debt-to-income threshold, then yes, your student loans may prevent you from qualifying for a home loan.
Sometimes it’s worth the wait
The lending rules are there to protect you. If you can’t make your payments on time, if you struggle to make payments at all, or if your loans are in forbearance, then you aren’t ready for the financial responsibility of a mortgage.
If your student loans are preventing you from getting qualified for a mortgage, take heart. While it might be frustrating to have to continue to rent, it could be worth the wait in the long run.
Spending a few more years getting your student loans or other debts paid down could mean that you would qualify for a lower interest rate or a higher loan amount. Once you have a better credit history and more secure income history, you will have more options available when you finally are ready to take that leap into homeownership.