Student loan debt can be a drag on your homeownership dreams. In fact, homeownership among household heads between the ages of 24 and 32 declined 9 percentage points from 2005 to 2014, according to a Federal Reserve study. The researchers estimated that about 20% of the drop in homeownership during this time frame can be linked to the growth of student loan debt.
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It’s certainly possible to buy a home when you have student debt. But you might need to approach your home purchase differently to balance your debt-to-income (DTI) ratio. Before you decide to apply for a mortgage, consider the impact of refinancing your student loans. Carefully review your own circumstances and consider consulting with a financial professional before moving forward.
Let’s take a look at how refinancing student loans could affect your mortgage process — specifically, we’ll touch on…
- Student loan refinancing could affect your credit
- Student loan refinancing could affect your debt-to-income ratio
- Effects of student loan refinancing could vary by lender
- Avoid refinancing while a mortgage is pending
- Having a mortgage could affect your refinancing odds
- Student loan refinancing and buying a home
Because your credit is a primary factor that mortgage lenders consider, make sure that refinancing your student loans won’t hurt your chances of qualifying during the mortgage application process.
“A refinanced student loan will appear as new debt on a credit report and could have a negative impact on the buyer’s credit score in the short term,” said Ken Pederson, branch manager of Fairway Independent Mortgage in Lancaster, Pa.
“Lower credit scores can impact interest rates on their mortgage, the cost of private mortgage insurance and even the ability to qualify for a home mortgage.”
The effect will depend on your personal situation and how much your credit drops due to refinancing your student loan. In general, the bigger hit to your score, the higher will be your lending costs. But in many cases, the effects of a new hard inquiry on your credit report and a new line of credit can be mitigated in a relatively short period of time.
If you plan to buy a home in the next couple of months, “Sit tight, buy your home and refinance” student debt after you close on the home, Pederson said.
If you have a longer time frame before buying a home — at least six months — Pederson pointed out that it can be an advantage to refinance your student loans to a lower monthly payment first. Once you start making regular, on-time payments on your refinanced student loan, the effect on your credit score will generally become positive.
In some cases, planning to refinance your student loans first can improve your ability to buy a home, said Dan Green, founder of homebuyer education company Growella that is now known as Homebuyer.
“Refinancing student loans reduces your monthly [debt] obligations, which lowers your debt-to-income ratio,” he said.
The DTI ratio is a financial measurement that shows how much of your gross monthly income goes towards your total debt and how much money is leftover afterwards. The percentage is calculated by adding up all your debt and dividing that number by your income. The lower the ratio, the better.
Mortgage lenders typically look for a DTI ratio of 36% or less — including your mortgage — though some will work with borrowers who have a DTI ratio of 43% or higher, according to the Consumer Financial Protection Bureau.
You can present yourself in an improved light by refinancing your student loans first. However, it must result in a lower monthly payment in order for you to benefit. Usually, refinancing to a longer term with a lower interest rate will reduce your monthly student loan payment.
Another benefit of lowering your DTI ratio is that you could be preapproved for a larger mortgage amount. A bigger mortgage means a bigger home in many cases. But that’s less important if you don’t need a larger loan — which also may mean a larger monthly mortgage payment. Measure your DTI ratio using our Debt-to-Income Calculator.
Before you take the plunge, Pederson suggested discussing your options with a mortgage loan officer. Depending on the mortgage lender and the home loan program, their view of student loans could vary.
A conventional mortgage might have different underwriting requirements related to student loans than a loan from the U.S. Federal Housing Administration, U.S Department of Veterans Affairs or the U.S. Department of Agriculture.
“All these programs have slightly different viewpoints on how lenders should look at student loans, especially if they are in deferment,” said Pederson. Deferment is when you pause student loan payments for a period of time.
Talking to a loan officer or mortgage broker can give you an idea of your options. The same applies if you hope to use grants or other alternatives to make a down payment on a home. Working with an expert will help you determine how refinancing can fit in.
You may find it’s the right choice for you to refinance student loans before or after closing on a home. But experts caution against beginning the process while the mortgage is pending.
Even if you’re approved and the home is under contract, Pederson and Green both recommended holding off on refinancing your student loans at this point.
“Every lender has to check credit again, just before settlement,” said Pederson. “If we see any new inquiries or loans, this new information has to be researched and can cause the file to go back into processing and underwriting.”
Applying to refinance your student loans while your mortgage is pending could put your home purchase at risk.
Depending on the situation, having a mortgage could impact your ability to refinance student loans. A high DTI ratio, as a result of your mortgage, could result in a rejected refinancing application. The lender may decide your income isn’t high enough to pay the mortgage and also comfortably make payments on the new refinance loan.
But if you make mortgage payments on time, have a high enough income according to the lender’s requirements and have a qualifying DTI ratio, a home loan shouldn’t hinder you from getting a student loan refinanced. In fact, making on-time mortgage payments could help improve your credit score.
Whether you should refinance student loans before or after buying a home depends on your goals and individual situation. The biggest impact comes from whether or not your debt-to-income ratio due to student loans affects the mortgage and could prevent you from qualifying. If that’s the case, refinancing might lower your monthly payments enough to allow you to get a mortgage, and turn homeownership from a dream to reality.
Sage Evans contributed to this report.