When it comes to buying a home these days, many Americans -- and not just those fresh out of college -- face a significant hurdle in the form of student loan debt. This hurdle is challenging, but not impossible to overcome.
So can you buy a house if you have student loans? It depends on the circumstances. Your path to becoming a homeowner, despite student loans, starts with understanding how they affect mortgage loan qualification.
High student loan debt and buying a house
The problem of high student loan debt and buying a house has become more severe in recent years as the level of student loan debt outstanding has soared. Total student debt owed now tops $1.5 trillion, more than double what it was a decade ago. While the typical student loan borrower owes between $10,000 and $25,000, the New York Federal Reserve Bank reports that over 7 million Americans owe more than $50,000 in student loans.
While one may associate student loan debt with recent grads, the New York Fed's figures show that it has become a lingering problem. Seventy percent of student loan debt outstanding is owed by people aged 30 and over. In fact, the amount owed by people aged 40 and over exceeds the amount owed by people under 30.
All of this has a dampening effect on home ownership in general. As young adults graduate with student loans that may take years to pay off, it can delay their entry into the housing market. As Nicolas Retsinas, a Senior Lecturer of Business Administration explained to HSH.com, "Student loan debt disproportionately impacts young households, which are typically the heart of the first-time homebuyer market."
Restricting the supply of first-time homebuyers in turn hampers the ability of existing homeowners to sell their starter homes and move up to larger properties. When older homeowners are themselves still paying off student loan debt, it is difficult for them to upgrade to more expensive properties.
Can't get a mortgage because of student loans?
The financial burden of rising student loan debt has been compounded by tighter underwriting standards used by mortgage lenders since the housing crisis.
"Lenders used to make exceptions for things like a high debt-to-income ratio," explained Retsinas, "but now, in response to (past) widespread mortgage defaults, they are more carefully scrutinizing the ability of borrowers to repay their loans. In some ways we've overcompensated and are denying loans to people who have OK credit, but clearly we are living in a more risk-averse time."
Dominic Turano, a Washington D.C.-area loan officer, echoed that sentiment, telling HSH.com "Someone with a boatload of student loan debt may have a hard time qualifying." Still he sees a silver lining, pointing out that student loan debt can improve a consumer's credit score if the payments are all made on time. This can be a valuable step toward building a positive credit history, along with paying rent on time.
These comments touch on two ways student loan debt can most directly impact your ability to get a mortgage: by affecting your debt-to-income ratio, and by shaping your credit history. You can still get a mortgage loan if you have student loan debt, but you must overcome those two potential hurdles.
Do student loans count against your debt to income ratio?
The debt to income ratio, commonly known as the DTI ratio, measures your monthly debt payments as a percentage of your monthly income. The payments you would be making on a mortgage are included in those debt payments when you apply for a mortgage.
Different loan programs have different standards, but generally speaking the higher your DTI ratio, the more risky your loan is considered. A DTI ratio above 50 percent will almost certainly mean getting turned down for a mortgage, and a DTI ratio approaching 50 percent is likely to mean you may get relatively unfavorable loan terms.
The more debt you have, the higher your DTI ratio becomes -- and this includes student loans. If you apply for an FHA mortgage, your student loan debt is factored into your DTI ratio based either on a monthly amount to pay off the balance over the life of the loan or the greater of the following:
- One percent of the loan balance, OR
- The current loan payment
Many borrowers ask, "Do mortgage lenders count deferred student debt?" The significant thing about the above formula is that, even if your current payments are $0 because of a loan repayment deferment or other leniency, some amount of the debt still counts against your DTI ratio.
Conventional loans are a little more forgiving when it comes to factoring student loans into your DTI ratio. For loans in deferment or forbearance, the underwriter can use either 1 percent of the loan balance or a monthly amount that would pay the balance off over the life of the loan, but if your payment has been reduced due to an income-driven payment plan, the underwriter can use your current payment when calculating DTI, as long as you can document that payment -- even if the payment is $0.
The upshot is that because student loans count against your DTI ratio, before you apply for a mortgage you need to be earning enough income to offset their impact on that ratio. If you are applying for a conventional mortgage, one way around this might be to sign up for an income-driven student loan payment program before you apply for your mortgage.
Can I get a conventional loan with defaulted student loans?
Besides impacting your DTI, student loans can impact your ability to buy a home if late or defaulted payments have damaged your credit history.
If you are applying for an FHA loan, your application is checked on the Credit Alert Verification Reporting System, or CAIVRS. This is a database of all federal debt payment programs. If CAIVRS shows you have defaulted or have payments delinquent on federally-backed student loans or any other form of federal debt, you may not be eligible for an FHA loan until the situation is resolved.
Even if you aren't applying for an FHA loan, any defaulted or delinquent payments on student loan debt is likely to have damaged your credit history. Unless these occurrences are long in the past and have been replaced by a more positive payment history, expect these incidents to reduce your credit score and thus reduced your chances of qualifying for a mortgage.
Approaching home buying with student loans
The impact on your DTI ratio and possible damage to your credit history are specific reasons why student loan debt makes it more difficult to buy a home. Still, while it may be more difficult, it is far from impossible.
Before you apply for a mortgage or even start looking at buying a home, you should do three things:
- Make an estimate of your DTI ratio. This entails comparing all your monthly debt payments to your income.
- Estimate mortgage payments. In addition to your student loan payments and any other debt payments, use a mortgage calculator to see what your monthly payment on the type of mortgage you are considering might be.
- Check your credit history. See if your credit score has been damaged by any late or missing payments, and take steps to rectify any problems. Check back later to see if this has improved your credit score.
These actions should help you understand the challenges that you may face when you apply for a mortgage, and understanding those challenges is the first step in overcoming them.