The Impact of Student Loan Debt on Homebuying

Key strategies to help you overcome educational costs.

You put your head down, studied hard, and dedicated time and energy to achieve a better education. You should be proud of that decision. As the age-old saying goes, nothing in life is free. For most of us this is mostly true — whatever lifestyle you desire is earned with hard work. And though a higher education is the time-tested way to increase one’s earning power, it comes with a steep bill (again, for most of us, a.k.a. those who never earned a scholarship or had a family who could foot the bills). When it comes to making your first home purchase, outstanding college loans won’t help your cause, but they’re certainly not a deal-breaker. With a little savvy, and sound financial management, you can purchase a home — and make it a smooth, worry-free process — despite your student debt.

Where do first-time homebuyers with student debt start?

The first step to take as a homebuyer with student loan debt is to realize it’s just like any other debt you carry. Home mortgage underwriters aren’t as concerned with the type of debt in your financial landscape — whether it’s for university credits, a car, or credit card — as they are with its aggregate amount. When this number is compared to your total income, the result is the all-important debt-to-income ratio, or DTI.

Your DTI is the fundamental indicator of your ability to pay an estimated monthly mortgage bill on time. (To estimate your DTI, use our CrossCountry Mortgage calculator.) If it’s judged healthy enough, and you meet other requirements, you’ll be granted a letter of mortgage pre-approval. With a home loan pre-approval in hand, you’re ready to house hunt.

How do you secure a mortgage pre-approval with student debt?

If your DTI is discouraging, there are a number of ways to bring the ratio down and set yourself up for a mortgage pre-approval:

• Pay down your debt. There are two ways to lower your DTI: decrease your debt or increase your income. However, this doesn’t represent an ‘either/or’ choice, because the best strategy is to decrease your debt by increasing your income. If you have a raise or tax refund coming, or an opportunity for a part-time job, you can improve your DTI by using the extra money to pay down your debt. Also, underwriters like to see an established work history before considering the extra income, so debt reduction represents a more immediate benefit than an increase in income.
• Consolidate debt. DTI is a measure of monthly debt expenses against monthly income. Lowering your regular debt payments — even if your overall burden remains unaffected — will benefit your cause. If you have multiple monthly debt payments, a debt consolidation loan may help you shrink their combined effect on DTI.
• Go halfsies. Having a co-signer on your mortgage application is a good way to overcome the student loan problem. Trust is the obvious focus in this scenario, so you’ll want a long-time friend or responsible family member to watch your homebuying back.
• Build your credit score. Your credit score has a big impact on underwriting, and there are ways you can improve it without actually decreasing your debt. If you have credit card accounts that are paid off, it’s best not to close them, since the length of your credit life directly contributes to your score. However, this isn’t a green light to open new lines of credit, especially during the home mortgage application process, as this will have an unfavorable impact.

Are there ‘debt-friendly’ loan programs or other assistance?

Conventional home loans are usually not in the cards if your debt burden is too heavy, because (a) your DTI is too high, and (b) you won’t have an adequate down payment for the purchase. (If you have cash on hand, it’d be wise to use the money to pay down your debt.) However, a number of government mortgage products and first-time homebuyer programs make it easier for people with significant debt to purchase a home:

• FHA home loan. Federal Housing Administration home loans are available with down payments starting at 3.5% and more flexible credit requirements than conventional loans.
• VA home loan. The Department of Veterans Affairs offers Veterans, Servicemembers, and eligible surviving spouses VA home loans with the best mortgage down payment available: 0%. And there’s no mortgage insurance required.
• USDA home loan. The USDA Rural Development 502 program offers 0% down payment, low-interest home loans for lower-income applicants in specific areas.
• Grants. Remember that bit about nothing in life is free? Here’s an exception: There are financial assistance grants from state, federal or community programs, with no interest or repayment required.
• Second mortgages. These are low-interest loans for a down payment on the primary mortgage, which you likewise pay off over time. ‘Forgivable’ second mortgages don’t require repayment as long as you live in the residence for a certain amount of time.
• Matched savings. This type of program helps prospective homebuyers build a down payment savings account by providing matching funds along the way.

Bonus information: Student Loan Cash-out Refinance.

If you own a home now, you may be able to refinance to pay off student loan debt with a Fannie Mae Student Loan Cash-out Refinance. Under the loan’s rules, at least one student loan must be paid off completely with the proceeds of the refinance, and the funds must be sent directly to the student loan servicer. At least one borrower must be obligated on the loan being paid off. Your loan originator can tell you more.

Where should you start?

As a first-time homebuyer with student debt, your first call should be to a qualified, reputable home loan officer.Get in touch with one of our expert loan originators to help you find the perfect loan product and get started. Call now for a free lending consultation!