I’m not exactly sure when it happened, but I’ve become obsessed with real estate — and by that, I mean looking at apartments on Zillow and Trulia, while daydreaming about all the possibilities of “my new home.”
But as much as I would like to dip my toes into homeownership, I’m one of the 44.7 million Americans who have student loans, which means that getting a mortgage with favorable terms (aka a sweet interest rate and affordable payment) can be tricky.
Still, I don’t want to miss out.
So, I did some research and spoke with a member of the Association of Independent Mortgage Experts (AIME), to come up with a plan to increase my chances (and yours, too) of securing a mortgage while juggling student debt.
How student loans can impact your ability to buy a house
Technically speaking, having student loans won’t automatically disqualify you from the home buying race.
However, they can affect these three factors, which are crucial for getting a mortgage:
- Your down payment.
- Your credit score.
- Your debt-to-income ratio (DTI).
Let’s examine each of these carefully.
Your down payment
One of the ways student loans can affect your ability to get a mortgage is by inhibiting how much you can save each month for a down payment.
The rule of thumb used to be that you needed to put at least 20% down on a house to get the loan, but that’s no longer the case.
Read more: Are 20% Home Down Payments History?
Rocket Mortgage, which is one of the nation’s top mortgage lenders, reports that the average down payment in the U.S. is actually 6%. However, it’s possible to get a house with as little as 0% down, depending on the type of mortgage you get (more on that later).
There is a very valid argument, as there always has been, for putting down the full 20%, though. When you put more down, your housing payment will be lower, which can make balancing mortgage and student loan payments much more realistic.
How much you’ll need to have saved (whether you go for a 20% down payment or not) will ultimately depend on the value of the home you want to purchase.
For example, say you stick to a nice low number of $150,000 for your first home, you’d need $30,000 for a 20% down payment. Or, if you opted for the national average of 6%, you’d need $9,000.
How to tackle this
- Apply for down payment assistance. There are many programs at the federal, state, and local levels that provide down payment assistance for first-time homebuyers, you can check a complete list here.
- Tap into your IRA. The IRS allows you to withdraw up to $10k from your IRA, without penalty, for the purchase of your first home.
- Borrow money from your 401(k). You’re typically allowed to borrow up to half of your 401(k) balance for the purchase of your first home. While you can do this, drawing from your retirement account should be one of your last options (you can read why in our article here).
- Consider refinancing private student loans or applying for an income-driven repayment plan (IDR) if you have federal loans. Both of these options can help you lower your monthly payments, and allow you to save more money each month.
Your credit score
Jamie Cavanaugh, chief operating officer at Amerifund Home Loans and member of the Association of Independent Mortgage experts, says that besides determining your eligibility for a mortgage, your credit score is the sole most important factor in determining your interest rate.
She also stresses that having student loans isn’t necessarily bad for your credit. In fact, if managed responsibly, your student debt can actually work in your favor.
The issue comes when you:
- Have a history of late or missed payments.
- Owe more than what you originally borrowed.
So, what’s a good credit score to get a mortgage?
If you’re going for a conventional loan, which is any type of mortgage that isn’t backed by the government, you’ll need a credit score of at least 620 to qualify. If you’re applying for a government-backed loan, such as an FHA loan or a VA loan, then you’ll need a score of at least 580 to qualify. Cavanaugh says:
“Anything over a 740 credit score is considered top-tier or excellent credit. If it falls between the window of a 687 to 739, that’s where your higher interest rates are going to come in.”
How to tackle this
- Pay all your bills on time, including your student loans. Late or missed payments can stay on your credit score for up to seven years. Make sure you pay everything on time or talk to creditors if you’re going to be late on a particular month, to see if they can give you a timeframe to pay before reporting any negative activity to the credit bureaus.
- Keep debt at bay and pay off balances, if possible. Most students can’t afford to pay their loans while in school. Once they graduate, all of that unpaid interest becomes part of the principal balance. This is how you end up owing more than what you originally borrowed. The best way to attack this is by avoiding additional debt at all costs, plus putting any extra money that comes your way toward reducing your student loan balance.
- Check your credit report for mistakes. Some of the most common errors you’ll find in your report are closed accounts that appear open, debts that appear more than once, or incorrect balances. Before applying for a mortgage, request a copy of your credit report, to make sure everything is in order. You can get a free copy by visiting AnnualCreditReport.com. If anything seems amiss, you can report it to the bureaus, so they can correct it.
The debt-to-income ratio or DTI is a percentage that compares your monthly debt payments to your monthly gross income — in other words, how much you have left after paying for everything else. This measure is important for lenders as it lets them know the mortgage payment you’d be able to afford.
Cavanaugh says that,
“the debt-to-income ratio is a pass or fail scenario. Your loan is either approvable with that DTI or not.”
In this particular case, your student loan balance doesn’t matter as much as your monthly payments. If they are on the higher side, or compromise a significant portion of your monthly income, this could basically get you denied for a mortgage.
So, what’s an ideal DTI to get a mortgage?
According to the Consumer Financial Protection Bureau, you’ll need a DTI of 43% or less, to be approved for a conventional mortgage. However, government-backed loans tend to be more flexible with this measure.
You can calculate your DTI by adding all of your minimum debt payments (excluding utilities and subscriptions) and dividing it by your monthly gross income. You can also use our calculator and make your life much simpler.
How to tackle this
- Pay off debt. Just like with your credit score, one way to improve your DTI is by reducing how much you owe. Now, this doesn’t mean that you need to pay off all of your debt before applying for a mortgage but just enough to lower your minimum due, to free up a bigger portion of your monthly income.
- Apply for an income-driven repayment plan if you have federal loans. With an income-driven repayment plan (IDR), your student loan payments are based on how much you earn, which can ultimately result in a lower monthly payment and DTI.
- Refinance your private student loans. If you have private student loans, you can try refinancing them to lower your monthly payment, which can also help your DTI. However, there’s a caveat: refinancing a loan means that you’re transferring them to a new account that doesn’t have any payment history, or isn’t well established. This could temporarily lower your credit score by a few points, according to Cavanaugh, so if you do this, give it a few months to “marinate” before applying for a mortgage.
Additional tips to buy a house with student loans
Avoid making any huge life changes just before you apply
I’m all about supporting everyone in their quest for their dream job; however, if you’re trying to get a mortgage, now may not be the right time to switch careers.
Cavanaugh says that one of the qualifying factors lenders look at when you apply for a mortgage is your employment history.
She says that switching jobs won’t necessarily affect your chances of getting approved for the loan, as long as you stay within the same line of work, are being compensated in a similar way, or earning more, and you’re still a W-2 employee.
The issue comes when you switch lines of work. If this happens, then you’ll need to wait a little longer to apply for a mortgage, so you can prove to the lender that you have a steady job and income.
Other things you should avoid just before you apply for a mortgage
- Applying for new credit lines.
- Closing accounts you’ve paid off.
- Refinancing debt.
These things can impact your credit score temporarily, so if you’ve done any of the above as of recently, it’s best to wait a couple of months before taking the plunge.
Explore every type of mortgage
There are two main types of mortgages: conventional and government-backed. Conventional loans tend to be less flexible when it comes to credit requirements and the amount of the down payment than government-backed loans, as they are originated based on risk.
Government-backed loans, like FHA, VA, and USDA are more lenient, as they are insured by a particular government agency. In other words, if you default, these agencies will take the fall.
When looking for a mortgage, Cavanaugh says to explore all of your options, as you could potentially save money, plus increase your chances of approval, especially if you apply for a government-backed loan.
With a government-backed loan, you could qualify with a credit score as low as 580, plus you’ll be required to pay a lower down payment. For example, FHA loans typically require 3.5% down, while VA loans don’t require you to put any money down at all.
Set up an appointment with your new best friend: the mortgage loan officer
Before you call your real estate agent and go house hunting, make sure you book an appointment with a mortgage loan officer to get pre-approved.
Getting pre-approved will give you an idea of how much house you can borrow, plus can speed up the home buying process since you’ll be able to make an offer faster.
Here are some of the things you’ll need for this part:
- Your driver’s license, passport, or state-issued ID.
- Copies of your two most recent pay stubs.
- Your social security number.
- Tax returns from the past two years.
- 60 days of bank statements.
- Asset account statements (retirement accounts, investment accounts, etc.).
Of course, you can also get pre-approved online, and shop and compare rates on your own using a website like Credible, which is both reputable and free. But when you have student loans, it’s probably better to talk to an actual officer, as they can give you pointers on things you need to improve to make sure you get the best terms and interest rates for your financial situation.
The cherry on top? Cavanaugh says that most mortgage officers won’t charge you a cent for any of these services. They only get paid once the loan closes, and the money comes out of the lender’s pocket, not yours.
When you have student loans, buying a house can feel like a balancing act. But with careful planning and an ounce of patience, you can successfully overcome all of these hurdles, and, before you know it, have a place to call your own.