If you owe a lot in student loans, it can be difficult to take on a mortgage as well. But buying a house when you have student loans is possible, as long as you make sure not to take on more debt than you can afford.
By carefully considering your options, as well as learning the best practices on how to buy a house while owing student loan debt, you can make choices that make sense for your financial situation.
Buying a house when you have student loans
Here’s what you need to do if you’ve got high student loan debt and are interested in buying a house:
1. Improve your credit score and check your credit report
2. Decrease your debt-to-income (DTI) ratio
3. Apply for preapproval and determine your homebuying power
4. Consider down payment assistance programs
● Plus Is buying a house when you owe student loans right for you?
The most important factor financial institutions consider when deciding whether to lend you money is your credit score. Fortunately, you can maintain a good credit score even with student loan debt. In fact, your student loan debt probably won’t drag down your credit score unless you’ve been missing payments.
Here’s how to boost your score ahead of applying for a mortgage:
- Pay your bills on time. On-time payments factor greatly in your credit score. Pay in full on or before your due date, and you can build a solid financial reputation.
- Manage your credit utilization. The ratio of your credit balances to your total available credit lines is called your credit utilization. For example, if you have credit lines totaling $3,000 and your credit balances total $1,000, your credit utilization is 33%. Ideally, you want to use as little of your available credit as possible.
- Don’t close old accounts. You might think that closing a credit card account is the way to go when trying to fix your credit score, but this often isn’t the case. An old account, especially if it’s in good standing, can help your credit. The longer your credit history and the older the average age of your accounts, the better your credit score.
- Use different types of credit. If you have a “thin file” with little credit in your past, there isn’t much for lenders to make a judgment about. A mix of revolving credit (like credit cards) and installment loans (like car payments or student loans) can show that you can handle different types of debt.
It’s also important to keep tabs on your credit score and to check your credit report before buying a home (request a free credit report here). Make sure your report is accurate and up to date.
If you have transactions you never made listed on your credit report, you can ask the credit bureau to remove the information, as well as to fix any errors. Learn how to dispute a credit report error here.
As with student loan refinancing lenders, a mortgage lender will calculate your debt-to-income ratio (DTI) to determine your ability to make monthly payments on a new mortgage.
When buying a house with student loan debt, you need to be aware of the impact your loans have. Many lenders follow what is called the “28/36 qualifying ratio” to determine if you’re eligible for their best rates. This means that you should spend no more than 28% of your gross monthly income on total housing expenses, and no more than 36% on all of your expenses (including the new mortgage payment).
If you’re not sure about where your DTI stands, try crunching the numbers with this calculator:
Debt-to-Income (DTI) Calculator
You can still buy a home if you don’t meet the 28/36 rule — and some lenders will still loan you money if your DTI is high — but you’ll have to decide if you’re really comfortable taking on a loan when you have a high DTI.
If your DTI is on the high side, here are a few steps you could take to reduce it:
- Increase your income by taking on a second job, setting up a side gig or asking for a raise.
- Refinance or consolidate your student loans to obtain a lower monthly payment — you might also get a better interest rate.
- Enroll in an income-based repayment program to lower the monthly payments on your federal student loans.
By boosting your income and trimming down your debt payments, you could free up your cash flow and make your home more affordable on a monthly basis.
That said, these steps will only help if your mortgage lender looks at your monthly student loan payments when considering you for a loan. Some mortgage underwriters base decisions on the percentage of your total student loan balance, rather than using your monthly payment amounts under an income-driven repayment plan. If that’s the case, you might need to shop around for a lender to ensure that you’re approved for a loan.
Preapproval from a lender can help you see what the costs and down payment requirements are. To determine what you qualify for, most lenders consider your two-year employment history, credit history, income and assets.
Here are some important things to keep in mind as you apply for preapproval when buying a house with student loan debt:
- A lender must look at most aspects of your financial history, at least in the short term. All funds need to be sourced and explained. Any large deposits outside of normal payroll will be closely scrutinized, and any major loans will be considered as well.
- Gifts from family are not unusual for first-time homebuyers. However, these also need to be sourced and accompanied by a lender’s gift letter. Lenders aren’t supposed to accept loans as down payments, so if a relative is lending you the money for a down payment, it’s not going to work — the down payment needs to be a gift if it’s not from your own funds, and it should be from someone with whom you have a close relationship.
- Check with the lender to ensure that you’re giving all documents needed for a comprehensive decision on your preapproval. Some documents you may need to submit include two years’ worth of W-2s, two years of federal tax returns, 30 days’ worth of pay stubs and two months of asset statements (including bank and retirement account statements).
- If you’re self-employed, you might need additional paperwork to verify your income. You could also be required to go through an income audit, where an accountant reviews your records and verifies your income.
- Additional documents may be required once the loan is underwritten, so make sure to check with the lender about any further materials you’ll need to get ready if you go ahead with the loan.
Once you have your preapproval, you can use it to help gauge which homes you can afford.
Additionally, sellers are likely to take you more seriously once you have a preapproval in place because they know the bank has already committed to providing you with financing.
Factor in private mortgage insurance (PMI) costs
Although the usual rule of thumb requires that you make a 20% down payment on a home, it might be possible to put down less money upfront. But if you have a smaller down payment, you might have to pay private mortgage insurance (PMI).
PMI is typically a monthly premium added onto your mortgage payments, and it’s meant to protect the lender in case you fall behind on your repayment. When figuring out how much home you can afford, remember to take PMI into account if your down payment is lower than 20% of the home price.
There are a number of down payment assistance programs that are acceptable to lenders. Many states and cities offer these, including some that allow you to use sweat equity if you want to build a new home.
It’s also possible to take advantage of federal loan programs, even if you have student loans. You may qualify for an FHA loan, which would mean a down payment of as little as 3.5%.
If you choose to buy in a more rural area, you might also qualify for a USDA loan, which requires no down payment at all. And don’t forget about VA loans if you’ve served in the military.
Research your options, and speak with a knowledgeable mortgage broker to find out what programs you qualify for at the federal, state and local levels.
Even if you have a good idea of how to buy a house with student loans, you should consider whether you’re actually ready for home ownership before you jump in. Figure out how comfortable you are with carrying two large debts over long periods of time.
Do you feel confident about your income? Is it large enough to comfortably afford a mortgage payment on top of your student loan payments?
Review your priorities, too. Will buying a home on top of having student loans require you to cut down on your retirement contributions? Will you have to dial back in other areas of your life?
Consider what matters most to you, and plan accordingly. Make sure to shop around for a mortgage as well, since getting a good deal will make homebuying all the more feasible. This comparison tool from LendingTree is a good place to start, as well as asking around any family and friends who’ve bought property recently.
But most of all, know that once you have a plan for buying a home, there’s nothing wrong with taking the leap — even if you do have student loan debt.
Rebecca Safier contributed to this report.