How to Buy a Home Even with Student Loan Debt

Anything you think is in your way can be removed if you really want to be a homeowner.  In fact, you’ll find out that some commonly perceived roadblocks are only myths, and you don’t need to delay your dreams anymore. If you are hesitant about moving forward, my new 5-week series is just for you — The 5 Most Common Home-Buying Myths BUSTED.

Myth:  I can’t buy a home; I have too much student loan debt.

Truth: You can buy a home even with student loan debt and there are even special types of loans for people like doctors who have way more school debt than most of us. Let’s find out how!

Is student loan debt holding you back from being a homeowner?

You’re not alone.

Many millennials are feeling the pinch when it comes to buying a home, which can explain why the percentage of first-time buyers who tend to be in this age group has dropped.

Having a monthly $200 to $300 student loan payment does mean that there’s less money for a down payment, less for a future mortgage payment, and ultimately the less home you can afford.  Plus, the cost of living in the Boston metro area doesn’t help when you’re young and still early in your career.

However, don’t automatically assume you’re facing a roadblock to homeownership if you have this debt.

There are ways to work with lenders and assistance programs to make your first home purchase a reality — and even more affordable despite your student loans.  

I understand that you may be grappling about whether you should pay off your student loan debt first before you even purchase a home. That could be an option, but don’t make it your only one.

You don’t have to delay years until becoming a homeowner, especially if you have substantial student loans. You’ll learn about some options that could help you make homeownership happen much sooner than you think!

And always remember to please consult with your own financial advisor to determine what is best for your situation.

How Lenders Look at Student Debt

Let’s get to the basics first. When you buy a home, a lender will look at your debt-to-income ratio or DTI.

It’s the amount of recurring debt you have monthly compared to your gross monthly income.  In a lender’s eyes, your DTI is more important than your credit score or how much money you have for a down payment.

Why?

A lender needs to consider your recurring debt — such as a car loan, credit card payments AND your student loan(s) — in order to determine if you can afford more debt with a monthly mortgage payment.  

And that’s where your student loan debt combined with a mortgage can tip the scales in the DTI ratio, pushing it higher and ultimately affecting your ability to get approved by a lender.

Lenders want to see a low DTI. Most financial experts recommend a DTI between 33-36% — it’s considered a good balance between debt and income. 

Some lenders will consider a maximum DTI of 43% or slightly higher.  Your debt obligations can easily grow when you do have a student loan plus car payments and credit card bills. (It’s not usual at all!) That’s why some lenders will carefully look at your income and assets to verify your ability to pay back the loan despite a higher DTI.

This higher DTI may make many of you uncomfortable, and we agree. Remember that what a lender says you can qualify for can be much higher than what you are comfortable spending each month!

However, most lenders like to stick to the 28/36 rule. And that’s where the 36% DTI from above comes into play.

• The 36% is the back-end ratio and equals your entire monthly housing costs expenses (principal, interest, mortgage insurance, property taxes) plus other debts (student loan, car loan, credit cards, etc.) divided by your gross monthly income. It’s the DTI we explained above, and you don’t want to go above 36%.
• The 28% is part of the front-end ratio equals your monthly housing expenses (principal, interest, mortgage insurance, property taxes) divided by your gross monthly income. Your other recurring debt is not included. Again, a lender doesn’t want to see it above 28%.

Keep in mind, your DTI and the 28/36 rule have nothing to do with your credit score or how well you pay back your debt. It’s looking at the amount of debt obligation you currently have when compared to your income. Not whether you’ve been good at paying your student loan and other debt each month. (But keep doing that too!)

And that’s why it can be frustrating for many first-time buyers with student loan debt who have good credit scores.

How to Lower Your DTI

If you need to lower your monthly debt and obligations, start with your student loan lender(s). Here are some options to consider. Remember to always consult with your own financial advisor before pursuing.

• Graduated repayment plan – payments start low and rise every two years as your income should rise.
• Loan consolidation – if you have more than one student loan, combine them into one with a lower interest rate.
• Lengthen your payback term – spread out your loan repayment over more years to lower your monthly obligation. This will increase you long-term interest payments so carefully way the pros and cons of this strategy.

Examine all of your financial obligations and find other ways to lower you DTI:

• Consider bumping up your monthly income with a side job … every little bit could help your cash flow and savings.  
• Don’t buy a car and use public transit to eliminate a recurring car loan debt.
• See if you can negotiate a lower minimum monthly repayment requirement on your credit cards, especially one that is on the higher side. Some credit card companies are willing to work with you if you have a good credit score and payment history.

Shop Around for Lender

When you have student loan debt, you need to find a mortgage lender who is willing to work with you and offer programs that may be geared toward borrowers just like you.

You don’t want to work with lenders whose underwriters just look at your entire balance of student loan debt and not your current monthly payments compared to your income.  You will likely not qualify for a mortgage loan with them. It won’t matter to them if you have lowered your monthly payments with a graduated repayment plan – they will calculate your DTI by using the percentage of your total loan balance.

Many lenders work with state and federal assistance programs, and may have a better track record when dealing with first-time buyers with student debt.  Your college or graduate degree is worth something and it should continue to advance your career and your earnings. These programs below will help jump start your ability to make homeownership a reality.

Increased 2023 Loan Limits Can Help

The Federal Housing Finance Agency plans to raise the conforming loan limits for 2023. The new baseline conforming loan limit will be $726,200– in most housing markets, an increase of $79,000 compared to 2022.

These increase loan limits can make it easier for many buyers to qualify for conforming loans backed by Freddie Mac and Fannie Mae. This means many buyers won’t need to qualify for a jumbo loan, which requires a larger down payment. This is good news for those of you with student loan debt and constrained cash flow.  

Tapping into Federal Loan Programs

There are several government programs that offer loans to borrowers with student loans. Each has different requirements and may not be a good option for you. However, one may make your homeownership dreams comes true.

• Fannie Mae HomeReady Mortgage  — allows up to a 50% DTI and 3% down payment.
• VA Loan Guaranty – Buyers who have served in the military can qualify for a loan with 41% DTI. That can be overridden if some of your income tax free.
• FHA Loan – According to official FHA guidelines, borrowers are generally limited to having debt ratios of 31% on the front end, and 43% on the back end. But the back-end ratio can be as high as 50% for certain borrowers, particularly those with good credit and other “compensating factors.”  The DTI could be updated for 2023.

If you need any help getting started or would like help connecting with a reputable lender, please reach out anytime at kara.trombly@suburbanlifestyle.com