Buying a Home with Student Loan Debt
Just 20-30 years ago, the age of first-time home buyers skewed lower than it does today. With many young adults graduating into an economy with stagnant wages and a lot of competition, want-to-be buyers often now have less work experience, lower relative income levels, and less money saved for down payment than did graduates of an older generation. Millennials also carry higher levels of federal student loans and debt than ever before.
According to a study by American Student Assistance, 55% of student loan holders said their debt is causing them to put off homeownership, despite historically low mortgage rates and a wide array of low-downpayment mortgages available to first-time buyers. Many would-be buyers aren't even applying for loans or considering buying a home because they are worried that their debts will make homeownership impossible.
The truth, though, is that homeownership and student debt aren't mutually-exclusive.
What goes into a Pre-Approval?
As a potential home buyer, one’s ability to get approved for a mortgage is based on three main factors: their down payment amount, their current credit score, and their household income relative to their household debt (debt-to-income or DTI). The key to being able to maximize their buying strength is making each of these factors as strong as possible.
How do these factors affect you?
You have the ability to control for how aggressively you save toward a down payment, and how strong your credit is by making payments on time, etc. But a lot of buyers get tripped up by DTI; you can’t control your income, so this piece of the puzzle is often seen as unalterable. Your debt-to-income ratio is a percentage which shows the amount of your monthly income required to repay your debts. For example, if you earn $2,500/month and had a monthly debt obligation of $1,000, your debt-to-income ratio would be 40%. DTI is heavily influenced by where you live because of the cost of rent, but in general your DTI must be 43% or less in order to get mortgage-approved. In general, higher student loan debt does negatively impact the DTI, and consequently the buying power of young adults today. The higher the student loans a potential buyer carries, the less home they can afford in general. BUT having loans does not have to be a barrier to entry in the housing market. Most people have the means to reduce your monthly student loan payments, which can help them with their home loan approval.
How do you reduce your DTI in relation to student loans
There are ways to reduce what you owe on your loans each month to help you qualify for "more home". The first method by which to reduce your monthly student loan obligation is to switch to a graduated repayment plan on your loans. By doing this, the payment starts low, then rises every two years to meet the rising income of a typical young adult. With lower monthly payments, your debt-to-income ratio is reduced, which can help you qualify for your home loan at a younger age.
Another approach you can take is to request a lengthening of your payback period, known as your "term". By lengthening your term to 15 years or 20 years, you can reduce the amount that you owe each month, which lowers your DTI. This will increase the long-term interest costs of your student loans, but will lower your monthly obligation and make your home-ownership dreams more of a reality. This strategy takes some long-term thinking and should be done with careful consideration.
The final way to reduce your monthly student loan obligation is by seeking out debt consolidation where possible. It is likely that your student loans are of different amounts, and at different rates of interest. By consolidating your loans, you can combine your principal balances together; just make sure you find an option at a lower interest rate.