If you’ve been out of college for a little while — or a long while — then you might be thinking about leaping homeownership. But if you also still have student loans to repay, then you are probably wondering whether you should clear those first.
Should you repay your existing debts before you undertake new ones? Or is it okay to purchase a home despite lingering student loan debt?
As with most financial decisions, the answer is that it depends. “Each situation is different, so what we look for is the client to guide us on what they feel comfortable doing,” said Jay Dacey, a senior loan officer with Metropolitan Financial Mortgage Company in Minneapolis. “If they can afford the payment and we can get them to qualify, that’s a good sign. If we can qualify them for a home and they don’t feel comfortable having that payment, it may make sense to continue living rent-free with parents and/or in a rental they can afford.“
To help you determine the best answer for your situation and goals, let’s take a look at some of the arguments for waiting and some for going ahead with buying a house while you still have student loan debt.
Reasons to pay off your student loans first
1. Your debt-to-income ratio is too high
When lenders decide whether you qualify for a mortgage, they review how much of your monthly income is devoted to debt repayments, such as payments for student loans, auto loans, and credit card debt. The overall result is your debt-to-income ratio (DTI), which further breaks down into the front-end and back-end ratios.
- Front-end ratio: The percentage of your income consumed by mortgage expenses
- Back-end ratio: The percentage of your income consumed by all debt burdens
To approve a mortgage, most lenders want potential homeowners to maintain a front-end ratio no greater than 28 percent and a back-end ratio no greater than 36 percent.
Some lenders allow back-end ratios as high as 43 percent, but that doesn’t mean you should feel comfortable taking on a mortgage that pushes your DTI to the maximum rate. (See “house poor” below.)
If your back-end DTI is roughly 30 percent or higher, it’s probably best to put off a home purchase until you’ve paid off more of your debt or achieved a higher salary. Remember, just because you can qualify for a loan, it doesn’t mean you should take one out.
Note that one way to lower your DTI is by decreasing your student loan payments, either by refinancing your debt with a lower monthly payment — which improves the ratio between your monthly obligations and income — or by enrolling in income-based repayment for federal student loans.
However, keep in mind that some mortgage types use a percentage of your total student loan balance (1 to 2 percent) to calculate DTI rather than using your actual monthly payment.
Alternatively, getting a raise or increasing your income through side work will also improve your DTI.
2. You don’t have enough for a down payment.
Many financial advisors recommend saving a down payment of at least 20 percent of the home’s purchase price. However, the Los Angeles Times indicates very few home buyers make down payments this large and reports from the National Association of Realtors revealed the typical down payment is 6 percent or less for 60 percent of first-time home buyers.
While getting a loan with a low down payment is common, if your down payment is less than 20 percent, then you’ll likely require private mortgage insurance (PMI), which can add 0.5 percent to 1 percent to your regular monthly mortgage payment. If you purchase a home for $100,000, for example, then you could face an extra $41.66 to $83.33 each month in PMI.
Is it a bad idea to buy a home if you don’t have 20 percent down? The answer depends on a host of factors, including:
- The price differential between the total cost of homeownership, including repairs and maintenance, versus the cost of renting. If owning a home is a substantially better deal in your part of the nation, even after adjusting for additional PMI payments, then there’s good reason to buy a home with a down payment of less than 20 percent. This calculator will help you to factor in variables such as interest rates, inflation rates, opportunity costs, the rate of both rent and home price increases, maintenance costs, and HOA dues, among others.
- The rising rate of home appreciation. Long-term appreciation of the real estate market is expected, according to Dacey, which can make a home a good financial investment. However, the data is mixed on how houses will appreciate in the short-term. Home prices rose steadily throughout the start of 2017, rising 7 percent in February, 7.1 percent in March and 6.9 percent in April compared with the prior year. But, because home prices have been rising much faster than income growth, many experts project fast-rising home prices are likely to hit a wall in 2018, according to CNBC. When prices rise more quickly, it can make more sense to pay PMI because the rapid appreciation in property value helps offset this extra cost.
- Your personal financial situation, including the size of your emergency fund, stability of your income, amount of other debt, and alternative uses of your down payment — are you likely to invest or spend it?
3. You don’t want to be house poor.
Homeownership requires more than simply paying a mortgage each month. It carries additional recurring — and unexpected — expenses that renters don’t face.
There’s regular maintenance costs of course, but also repair expenses for sudden problems: The roof starts leaking, the furnace breaks, the A/C needs to be replaced, the gutters need cleaning, the deck needs to be refinished, and the hardwood needs another coat of polyurethane.
Feeling exhausted yet? Your bank account will be.
Make sure that you have enough room in your budget to absorb these additional costs, not solely the cost of mortgage payments.
The best way to meet this demand is by purchasing a house that costs less than the price at which you’re qualified to buy. For instance, if you keep your back-end DTI to 25 percent or 30 percent instead of the lender-recommended 36 percent, then you can put the savings in a repair and maintenance fund.
4. You’re not sure where you want to be in 10 years.
Renting gives you the flexibility to change careers and move to new cities on a whim. Homeownership drastically limits that kind of freedom.
“If moving in the very near future is highly likely, the transaction costs of buying and selling would offset any potential short-term gains,” said Dacey. “If however, the client anticipated staying in the location for several years or more, it would likely be to their benefit financially to purchase a home.”
Sure, you can always sell your house, but that poses plenty of risks, hassles, and transaction fees. You could also rent out your house, but you may not want the experience of being a landlord.
If your job is unstable, if you’re contemplating a major career or lifestyle change, or if you’re just plain not sure where you see yourself in the next few years, then it’s best to wait before committing to owning a home.
5. There’s nothing wrong with renting for a while.
We know that everyone tells you you’re pouring money down the drain when you rent, but there’s also no need to rush into homeownership.
If your finances are out of shape or you’re not sure of your long-term plans, then it’s okay — even advisable — to wait until you have more security and clarity before committing to something as large as buying a home.
Reasons to buy a home when you still have student loans
First, you have to want to buy a home, and the factors in your personal life — your family, your relationships, and your commitment to a specific location — must point toward homeownership. In this sense, the only doubt in your mind should be financial, not emotional.
From this starting point, there is an array of factors that you should consider. The more of these criteria that you meet, the better. However, if you don’t meet one or two of the criteria, it isn’t an instant deal-breaker. Think of the following as a guide, not a mandate.
6. Your DTI looks good.
If your front-end DTI is significantly less than 28 percent, that’s a good sign that you might be ready to commit to a mortgage while still being able to pay back your student loans responsibly.
7. You’ve saved up a sizeable down payment.
If you’ve been able to pay down your loans and also save enough for a 20 percent or higher down payment, then that’s another sign that you could be ready to take out a mortgage.
8. You’re making enough money to handle the costs accompanying homeownership.
See “house poor” above. “It all comes back to the monthly obligation and your budget,” according to Brian Koss of YourLoanSherpa. Buying a home can make sense, as long as “you can handle the monthly debt obligation” and other associated costs.
9. You could get more for your money.
Aside from the prospect of building equity — which is undoubtedly a factor to consider — you could also quite literally get more for your money by buying instead of renting. “In many markets, the cost of renting is higher than owning,” Dacey said.
Depending on the market in your area, you might be able to enjoy a home with more square footage, both indoors and out, as well as better fixtures and nicer amenities for the same monthly payment as a smaller or less-updated rental property.
If you’re thinking of starting a family soon, then this extra space could become necessary. Or, if you’re currently by yourself and you simply want more room, you could always take on a roommate to help with the mortgage payment, thereby allowing you to channel that extra money into paying back your student loans and meeting other financial goals.
10. You have a low-interest student loan.
Student loans are typically the least pernicious types of debt compared to credit card debt and auto loans.
Student loan interest rates tend to be lower and allow an extended repayment period. They’re also unsecured, which means that you don’t risk losing any personal collateral should you need to stop paying them for a certain time. Though you would want to repay $10,000 in credit card debt ASAP, $10,000 in student loan debt is typically not so bad to pay off at the minimum payment rate.
Having student loans doesn’t necessarily put the kibosh on buying a home.
As shown, there’s no clear-cut right or wrong answer. There are strong arguments for buying a home right now, as well as equally solid arguments in favor of waiting. Make your decision based on your finances, priorities, and goals.
Paula Pant contributed to this article.