While a student loan can affect your ability to obtain a mortgage, it’s possible to have a student loan and a mortgage simultaneously. Mortgage lenders will consider all your debts, including student loans, plus other factors such as your credit history and income.
With student loan debt, you have many options for mortgage loans. You could be eligible for government-backed loans that offer competitive interest rates and little to no down payment.
Student loans can affect your mortgage, but there are many things to consider when deciding whether to carry student loan debt and a mortgage at the same time.
How Student Loans Affect Your Debt-to-Income Ratio
One of the key factors that lenders consider in a mortgage application is your debt-to-income (DTI) ratio, which is all of your monthly debt payments (student loans, car loans, credit cards, etc.) divided by your monthly gross income, which is your total income before taxes and other deductions.
Student loans increase your DTI ratio just as any other loan, which can impact your ability to pay for a mortgage. One general rule of thumb is your DTI should be kept below 36%, including mortgage payments. Some lenders may allow a DTI as high as 43% or even 45%, though it depends on several factors. The bottom line is, the lower your DTI the more likely you are to qualify for a mortgage.
How Student Loans Impact Your Credit Score
A good credit score is important for obtaining a mortgage or any other type of loan. Credit rating agencies consider several factors in determining your credit score:
• Payment history (35%)
• Credit utilization: Your available credit vs. your total debt (30%)
• Length of credit history (15%)
• Recent loans or credit card applications (10%)
• Debt mix: The type of debt you have, such as student loans, credit cards, auto loans, etc. (10%)
Paying your bills on time and reducing your debt load could significantly improve your credit rating. Of course, reducing your debt load can also improve your DTI ratio.
If you have any credit cards you don’t use very often, and are thinking of closing them, consider that doing so could negatively affect your credit score because it would reduce your length of credit history and your total available credit.
You can get a free credit report every year at AnnualCreditReport.com. This will include three credit scores from the nation’s credit reporting agencies: Equifax, Experian, and TransUnion.
It’s a good idea to do an annual credit check just to make sure where you stand. If there are any mistakes or signs of fraud, such as someone opening an account in your name, contact the bureau that lists the information to correct it.
Should I Pay Off My Student Loans Before Buying a House?
Whether you need to pay off your student loans before obtaining a mortgage depends on your financial situation and your ability to pay off both debts at the same time.
Paying off your student loans first would make it easier for you to obtain a mortgage, and would make it easier for you to cover your monthly mortgage payments. Eliminating your student loan debt could improve your DTI ratio, and probably your credit score, which would make you more likely to secure a mortgage at a favorable interest rate.
Another thing to consider is what housing prices are like in your area, how much they’ve risen over the past few years, and the likelihood that they’ll continue to grow.
For most people, their home is their largest financial asset, so waiting to buy a property could mean you would lose out on any gains in property values over that time.
If your student loan payments already take up a significant portion of your paycheck, then adding a mortgage payment on top of that could be unsustainable.
Of course, mortgage interest rates are bound to change over time, which has a significant impact on your ability to obtain an affordable mortgage.
You might consider how much time you have to pay off your student loans and what the interest rate situation is going to be.
For example, if you could pay off your loans within a year and mortgage rates are expected to fall, it could be worthwhile to focus on paying off that loan before taking on a mortgage.
The bottom line is, it depends on how much debt you can handle. As complicated as this is, you might consider meeting with a financial advisor who could crunch the numbers, help you draft a budget, and find the right approach.
Am I Eligible for Student Loan Forgiveness?
You might be eligible for student loan forgiveness, depending on your line of work and how long you’ve been paying off your loans.
Teachers, government employees, nonprofit employees, medical professionals, and the disabled could all be eligible for student loan forgiveness or cancellation.
You might also be eligible if your school misled you or the school closed. Another option would be an income-based repayment (IBR) plan, if you’ve made 20-25 years of monthly payments on your loan.
Can I Roll My Student Loan Debt into a New Mortgage?
While existing homeowners might be able to pay off their student loans by refinancing their mortgage, you can’t pay off your student loans with a first-time mortgage.
Even if you already own a home, there are many things to consider before using your home’s equity to pay off your student debts. For federally-backed student loans, you could lose the opportunity for student loan forgiveness or income-based repayment plans. You could also wind up with a mortgage that has higher interest costs than your existing student loan.
What about Refinancing a Student Loan?
If you took out a private student loan that wasn’t backed by the government, such as one obtained through a bank, credit union, state program, or a school, you might be able to refinance your loan at a lower interest rate.
Of course, this would depend on what interest rates were when you took out the loan and what the going rate is today. Refinancing could be a good option if it would reduce your interest payments.
This would not only make it less expensive for you to pay off your loan, it would also reduce your DTI in case you wanted to apply for a mortgage.
What Are the Best Mortgage Options for Those with Student Loans?
From conventional mortgages to those backed by the federal government, there are mortgage programs that allow low down payments or that minimize the impact of student loans on your DTI.
Federally-backed mortgages can be easier to obtain than conventional loans. Some of them offer mortgages with little to no down payment and low interest rates.
You can use our loan calculator to estimate what your monthly payments would be for different mortgage options and housing prices. If buying your first home, check out our first-time homebuyers guide for Arkansas and our Cassville First Time Homebuyer Do's and Don'ts.
Fannie Mae HomeReady Loans
HomeReady loans are mortgages available for those whose income is less than 80% of their area’s median. You can find out the median income in your area through Freddie Mac’s Area Median Income and Property Eligibility Tool.
HomeReady loans are available with down payments of as little as 3% and DTIs of up to 50%. You can also use gifts, grants, and other public support options toward your down payment.
Mortgage insurance (MI) is required and can be canceled after your loan balance drops below 80% of your home’s appraised value, and certain criteria are met.
A borrower’s monthly student loan payments will be included in their DTI. If a student loan is deferred or in forbearance, lenders will use 1% of your total balance or one monthly payment to calculate your DTI.
Freddie Mac Home Possible Loans
Home Possible loans are mortgages with more flexible requirements and terms than conventional mortgages and are available to homebuyers with incomes of up to 80% of their area’s median income. They require a down payment of as little as 3%, which you could fund through family, employer-assistance programs, secondary financing, and sweat equity.
Co-borrowers do not have to live in the home, and can be included in a borrower’s mortgage application for a one-unit residence. A co-borrower receives an ownership stake in the property and might help your financial position in obtaining a mortgage. They would also be responsible for helping you make the mortgage payments.
Borrowers may have rent-paying roommates and use that income to help qualify for a mortgage. Borrowers are also allowed to have another financed property.
Mortgage insurance (MI) is required, but can be canceled after your loan balance drops below 80% of the home’s appraised value and certain other criteria are met.
The maximum DTI for Home Possible loans is 43% for mortgages that are manually written (by humans). Many mortgages are written by computer programs, which consider your DTI, credit score, down payment, cash reserves, employment, and other factors.
Freddie Mac HomeOne Loans
HomeOne mortages are available to first-time home buyers with a down payment as low as 3% and no income limits. They’re also available for refinancing with no cash out. Co-borrowers are allowed, but only if the home will be their primary residence.
Mortgage insurance (MI) is required for those who borrow 95% or more of their home’s appraised value.
For both types of Freddie Mac home mortgages, your monthly student loan payment would be counted as part of your DTI. If you have no payments, because your loan is deferred, lenders would use 0.5% of your balance in determining your DTI.
FHA Loans
Mortgages backed by the Federal Housing Administration (FHA) offer more flexible requirements than conventional mortgages. Downpayments of as little as 3.5% are required for credit scores of 580 and higher. Credit scores between 500 and 579 would require a down payment of 10%.
Highly qualified applicants might obtain an FHA mortgage with a DTI of 50% or more.
Your student loan payments would be included in your DTI. If your payments are deferred, then 0.5% of your balance would be used to calculate your DTI.
The amount you can borrow with FHA loans depends on your location and the property want to buy. You can check the FHA’s mortgage limits online for properties in your area.
VA Home Loans
Mortgages backed by the Veterans Administration are available to active-duty servicemembers, veterans, and some surviving family members.
These loans require no down payment and no personal mortgage insurance (PMI), although the VA charges a funding fee of 0.5% to 3.3% of the total loan. You could pay this fee upfront, or add it to your mortgage.
A DTI of 41% is typically required, including monthly student loan payments. If your student loan is in deferment, lenders would calculate your DTI using either the payment listed in your credit report, or 5% of your loan balance divided by 12 (whichever is greater).
Before starting the application process, veterans need to obtain a Certificate of Eligibility (COA) through the VA’s eBenefits portal.
USDA Rural Development Loans
There U.S. Department of Agriculture (USDA) offers two types of Rural Development Loans for those in designated rural areas, with no down payment or private mortgage insurance (PMI) required. They do require a guarantee fee, with an upfront fee when you obtain a mortgage and an annual fee thereafter.
You can check your eligibility for either loan, based on income and location, at the USDA’s Income and Property Eligibility Site.
Both loans require a DTI no higher than 41%. For those with credit scores of at least 640, the USDA may include your monthly student loan payments in calculating your DTI, even if your loan is deferred or you’re in a payment plan. Otherwise, 0.5% of your existing student loan balance would be used.
USDA Direct Home Loans
USDA Direct Home Loans typically don’t require a down payment and offer mortgages with 33 or 38-year terms. Apply through the USDA online or at a local USDA service center.
USDA Guaranteed Loans
USDA Guaranteed Loans don’t usually require a down payment and are available to those whose income does not exceed 115% of the median household income for their area. Loans are available at 30-year terms, with rates set by lenders. You can apply for a USDA Guaranteed Loan through your local CS Bank.
Contact a Mortgage Lender Today
If you’re thinking of buying a home and would like to explore your options for low down payment home loans, or apply for a mortgage, please contact a mortgage lender, or visit one of our convenient locations in Eureka Springs, Huntsville, Harrison, Holiday Island, Berryville, Arkansas or Cassville, Missouri to speak with a loan officer.