Any debt is a potential obstacle to homeownership, but there’s one type that has some unique challenges: student loan debt.
Student loans are complicated, but if you know how they affect your financial profile, they don’t have to hinder your homeownership plans. “What we have to consider is how does the monthly student loan payment impact how much we can afford,” says Kyle Seagraves, certified mortgage advisor with the homebuyer education site and YouTube channel Win The House You Love.
On the surface, this seems like a simple calculation. A $400-a-month student loan payment would reduce the monthly mortgage payment you could afford by $400. But student loans offer a number of payment options other forms of debt don’t.
How you qualify for a mortgage changes if you’re taking advantage of student loan forbearance, deferment, or income-based repayment. And to add to the complexity, the way these situations are looked at changes depending on the type of mortgage loan you’re applying for. So student loans can limit not only how much house you can afford, but also influence what type of mortgage is best for your situation.
Pro Tip
If you’re on an income-based repayment plan, look into conventional loans because your lower monthly payments may help you qualify for a mortgage.
But if you understand the rules, you can minimize the effect student loans have on your housing options. Here’s what you need to know.
How Student Loans Affect Your Home Buying Choices
In many ways, student loans have the same impact on the home buying process as other types of debt. Because you owe money, you’ll be able to borrow less and it makes it more difficult to save up enough to make a down payment or to pay for closing costs.
But because of the variety of repayment options and types of loans, there are extra things you’ll need to consider when it comes to student debt.
Increased debt-to-income ratio
Your debt-to-ratio (DTI) is a calculation of the debt you owe compared to your gross income. Lenders are mainly concerned with what is known as your back-end DTI, which is used to determine how much they’re willing to let you borrow. “DTI is, in my mind, the biggest number, outside of credit score, that is used when qualifying somebody for a loan,” Seagraves says.
Your back-end DTI includes your existing monthly debt payments and your future mortgage payment. So if you make $5,000 a month, and all of your monthly debt payments plus your future mortgage payments total $2,000, your DTI is 40%. Here’s how that’s calculated:
The maximum DTI you’re allowed to have varies depending on the mortgage, but “… a good rule of thumb is 45%,” Seagraves says. However, that doesn’t necessarily mean it’s a good financial move to borrow as much as a lender is willing to give you. “A lender is not mainly concerned with a buyer’s financial health, what it’s concerned about is getting its money back,” Seagraves says. So he recommends that your monthly debt doesn’t exceed 25% to 30% of your monthly take-home pay, which isn’t just a lower number, but also factors taxes into the equation.
If you’re currently repaying your student loans, calculating DTI is simple. You’ll just add in your monthly student loan payments. But things get confusing if you’re taking advantage of student loan forbearance, deferment, or an income-based repayment plan (IBR). “The status of your http://paydayloanstennessee.com/cities/brighton student loan affects how [lenders] calculate your student loan payment in that debt-to-income ratio,” says Catalina Kaiyoorawongs, co-founder of the student debt financial wellness platform LoanSense.