In the United States, there is currently about $1.5 trillion dollars’ worth of outstanding student loan debt. By comparison, that’s hundreds of billions of dollars more than outstanding credit card debt! Also, about 20% of those paying off student loans are paying off amounts greater than $100,000.00 and the average monthly student loan payment is $300.00. It’s hard to imagine that you can ever finish paying off this debt, and be able to start the life you imagined when you first decided to go to college. That hopeless feeling is common among anyone who graduated college in the last couple of decades, but not many realize that it’s possible to have this debt AND also buy your dream home. You don’t have to pay off your student loans before buying a house, but it does have a couple of extra factors. Let’s break it down for you
#1 Student Loan Status
First you need to determine what status your student loans are in. Are they on an income based repayment plan,in forbearance, or currently in deferral? If they are, you should skip down to the 4th tip because you may have a different factor to deal with than if you’re on a standard payment plan. If you’re not sure, then read through all of the steps, and when you’re done, either check your student loans online or give a call to the company who is managing your loans to confirm your status.
#2 Debt to Income Ratio
Everyone who wants to buy a home has to conform with the concept of debt to income ratio. Essentially, that means that a lender will consider the monthly payments for all of the debt that you are responsible for, and then compare it to all of the income that you bring in each month. It then will create a percentage that they use to determine approvals and loan programs that you are eligible for (the number you want to stay around is 43%). Of course, having a monthly debt such as a student loan payment is going to drive that percentage up.
Another consideration is if you plan on having someone else on the loan with you. Something many people don’t realize is that you will have to include their figures for your combined debt to income ratio (yes, if they have debt, it is now considered as part of a combined percentage, which could have a negative effect). There are also benefits, because if they have good income and very little debt, that will help your overall combined debt to income ratio. Keep that in mind when looking into your mortgage options.
If after all of your efforts, you find that your debt to income ratio is still too high, you don’t have too many options left other than lowering your debt or making more money. If only making more money were easy, right? Some people think getting a second job will help, but if you have a part time job for less than 2 years, you may not be able to include that in your debt to income ratio. Your best bet would be working on getting overtime, bonuses, or asking for a pay increase, even if it is confirmed in a letter from your employer that it won’t be active now, but will be promised at a specified date. You can also consider the possibility of finding a better paying job, but also keep in mind that lenders will want to see you transition to a job that is in a similar line of work, and you want to avoid having an unemployment gap over 30 days. Pay structure is also important, so if you change jobs, you don’t want to switch from a 1099 to a W2 or vice versa. Stick with transitioning from a W2 to a W2 or a 1099 to a 1099.
The other option would be looking at ways to lower your debt. Your ratio will improve if you can eliminate some recurring debts entirely, and that’s always a worthwhile endeavor. Another focus might include reducing the amount of recurring debt you must spend. One way to do this with student loans is to consolidate and/or refinance them (be careful when refinancing student loans and make sure that you understand all repayment terms and what is best for your individual goals). There are many lenders out there willing to refinance even your federal student loans at a lower rate, and it would help lower the amount of your monthly payments if you consolidate to one payment each month.
#3 Know Your Credit Score
Particularly if student loan debt is a concern, you’re going to want to make sure that you have access to the best rates and programs available. In order to do that, you need a decent credit score. Check yours through annualcreditreport.com. If your average score is under 600, you’ll certainly want to do some work to improve your score before shopping for a mortgage.
#4 How to Deal with Forbearance, Income Based Repayment Plans or Deferrals
Is your student loan status one of the following: In Forbearance, on Income-Based Repayment Plans, or In Deferral? Up until recently, having student loans in one of these categories greatly limited the home loans available to would-be homeowners. Things have gotten much better. For some loan programs, lenders must count between 0.5 and 1% of your total outstanding loan balance if it falls under one of these categories. Because of the effect this can have on debt to income ratios, you may find yourself out of luck with some loan programs. This can be particularly troubling for those with student loan balances that are too high to be refinanced comfortably. Don’t worry! Conventional loan programs are much more likely to take only the amount you actually pay monthly into consideration.
There you have it. Having student loan debt does not and should not keep you from achieving the dream of home ownership!