Millennials, or those born between the years 1980 to 1998, have long dominated the consumer market. As such, this generational group should have also taken over the real estate market. But millennials continue to fall short of the classic American dream of being a homebuyer.
Why might that be? Well, hello there, student loan debt.
Owning a home has always been an expensive endeavor, yet coming-of-age homebuyers already face financial burdens from their college days. Millennials and Gen-Zers have on average $36,000 in student loan debt, as the Education Data Initiative reports in its 2021 study.
Even in the face of that stat, we have good news to share. Student loan debt doesn’t make it impossible to live out your dream of homeownership; it just makes it a bit more difficult because of its impact on your debt-to-income ratio (DTI), credit score, and down payment savings. If you’re considering buying a home with student loan debt, here are the most important things you need to know directly from expert real estate agents and mortgage professionals.
You build zero equity while you’re renting, and your payments are variable. Owning a home increases your equity and creates financial comfort in the long run.
- Edward Kaminsky Real Estate AgentCloseEdward Kaminsky Real Estate Agent at The Kaminsky Real Estate Group Currently accepting new clients
- Years of Experience 36
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- Average Price Point $2m
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The possibility of homeownership with student debt
Are you someone who desires to settle down in a home of your own soon? You certainly aren’t alone — 74% of adults see homeownership as the apex of the American dream. It’s a dream that pays as Edward Kaminsky, a real estate agent with over 35 years of experience in Manhattan Beach, California, shares, “You build zero equity while you’re renting, and your payments are variable. Owning a home increases your equity and creates financial comfort in the long run.”
This may seem impossible if you’re one of the 45 million borrowers in the U.S. with student loans and are worried about how that may impact your ability to buy a home. The short answer is that student loan debt doesn’t disqualify you from this undertaking!
The longer answer is that it could affect your chances of obtaining an affordable mortgage.
You may be ready to go house hunting ASAP, but you must first identify where you stand with your student loans. The best place to start? Take it from Richie Helali, HomeLight Home Loan’s Mortgage Sales Leader, who shares, “My general recommendation is to talk to a lender first. There’s nothing to be embarrassed about as everyone’s financial scenario is different. The loan officer’s job is to help you solve your unique situation and be in a better position to buy.”
How student loan debt affects your ability to purchase a home
Student loan debt isn’t viewed any differently than other forms of debt on your credit report. But unlike other forms, Kaminsky states, “Having student loans isn’t a bad thing because it’s the cheapest debt you can have. Student loan interest rates are pretty low – they’re designed that way.”
Yet there are specific ways which student loans might affect your ability to buy a home. This comes in the form of an increased DTI ratio, lower credit score if you have not been making payments, and impeded savings for a down payment.
Debt-to-income ratio is your monthly debt payments as compared to your monthly gross income. The number isn’t looking into the total debt you owe but rather the monthly payments you make on that debt.
Lending institutions use your debt-to-income ratio to understand what you can afford when it comes to a mortgage payment. A lower DTI is preferred as it shows you can manage all your debt obligations.
This is where student loans can hurt your chances of becoming a homeowner. Depending on your total monthly debt payments, including student loans, your DTI may be above the percentage that some lenders require. You could still be approved for a mortgage with a higher DTI, but you might pay a higher interest rate.
You can calculate your DTI by following these steps:
- Add up monthly debt and home payments, but exclude variable costs such as utility bills or entertainment costs
- Divide that by your monthly gross income
- Multiply that by 100 to get a percentage
How lenders calculate deferred student loan debt may increase your DTI. “Deferred loans need to be counted differently, either as .5% or 1% of the total outstanding balance. In most cases, if your credit report shows a $0 monthly payment, that is counted as 1% of the student loan balance,” Helali explains.
One percent of the balance of your student loan monthly may be vastly different from the actual monthly payment you make. For example, let’s say you currently have $23,000 in student loans to pay off. Lenders may automatically calculate your DTI with a monthly student debt payment of $230, yet your fixed payment may only be $100. You should know how specific lenders will calculate your student loan payments to avoid this disadvantage.
Don’t be discouraged if your DTI is higher than what lenders like to see. There are methods to alter monthly debt payments, such as refinancing, to support lowering your ratio.
Lenders view your credit score as a measure of your reliability for paying debt on time. A high credit score means you make timely payments, have a good credit history, and keep your credit utilization down.
“The minimum credit score for a mortgage is generally 620. If you’re looking at a jumbo loan, that increases quite a bit from 680 to 720,” shares Helali, and your student loans play a major part in whether you’re meeting that minimum.
Every payment you make on your student loans lowers your overall amount of debt. If you’ve made these payments on time, your student loans have supported you in building a higher score. If you’ve missed even one payment, your score could be negatively impacted.
The lower your credit score, the more lenders might see you as a high-risk borrower. You may still find a lender willing to offer you a mortgage, but be prepared for a higher interest rate and a larger down payment to offset the risk.
Saving for a down payment
Student loan debt also affects your ability to build savings for things such as down payments or emergency household funds.
On average, student loan borrowers are making monthly payments of $400+. That is hundreds of dollars every month that borrowers aren’t putting into savings. Without this, you may struggle to have the funds for a down payment, especially the traditional 20%.
However, you may be able to come up with a down payment if you have some savings. Certain mortgage types (FHA, VA, and some conventional loans) or down payment assistance programs provide opportunities for homebuyers to put down 5% or less, making it more feasible with smaller savings. Your state or local housing agency is a great place to seek out these unique programs.
How to buy a home with student loan debt
Even though student loan debt can impact your homeownership journey, it does not preclude you from it. There are steps you can take to find accessible, even affordable, mortgages.
First, consider refinancing or consolidating your student loans to lower your monthly payment. Remember how DTI is calculated by dividing your monthly gross income by your monthly debt payments? This is where that becomes crucial. Refinancing your student loans could give you a lower monthly payment, hence decreasing DTI and making you eligible for a larger mortgage.
Another method to lower your DTI to an acceptable level is to elect for an income-driven repayment plan. These are offered on federal student loans, lowering the monthly payments to make them more affordable based on income and family size. Payments can range anywhere from 10% to 20% of your discretionary income (the calculated difference between your annual income and 150% of the poverty guideline for your state and family size).
Student loan forgiveness is also a great opportunity for those who qualify, canceling the total or partial balance of your loans. Current programs include the Public Service Loan Forgiveness, Teacher Loan Forgiveness, or Closed School Discharge. It’s important to stay on top of updated details regarding loan forgiveness eligibility from the U.S. Department of Education to see if you could be taking advantage of forgiveness of your loans.
You’ll want to do all you can to lower your DTI to buy a home with student loans. A fourth method to support this is a common debt recovery maneuver: paying off manageable debts first. For example, lower-balance credit cards are easier to pay off, which can change your monthly debt payment. Kaminsky shares a similar and equally powerful method of getting debt under control: “Look at your highest interest rate first and start paying that down. You’ll pay less for this debt by focusing on it from the outset.”
Finally, you can explore different home loan types that are kinder towards higher DTI and lower credit scores. Consider an FHA loan as opposed to a conventional conforming loan. FHA loans are insured by the Federal Housing Administration, making them less risky for lenders. This combined with their 31% DTI and 3.5% down payment requirements makes homeownership more accessible for borrowers. But Helali warns, “There is a drawback: You’ll need mortgage insurance no matter how much equity you have in your home.”
Student loan and homeownership FAQs
What if I default on my student loans?
Defaulting on your student loans might make it more difficult, but not impossible, to qualify for a mortgage. When you default, you can hurt your credit score, which is often a sign of unreliability to lenders. You may want to consider loan rehabilitation first, working with loan holders to set up an appropriate payment plan and expunging the default from your credit history.
What if I deferred my student loan payments?
Student loan borrowers currently have access to a 0% interest rate and loan payment suspension due to COVID-19’s financial constraints on borrowers. Some may think it’s the time to buy a home, however, that depends on your mortgage type.
“Fannie Mae conventional loans count 1% of your outstanding student loan balance as the monthly payment when they see a deferred loan. FHA and Freddie Mac conventional loans will calculate your monthly payment as .5% of the outstanding balance,” explains Helali. Just because you see a $0 monthly payment doesn’t mean lenders do, so make sure you know how they count deferred student loans.
Bottom line: deciding whether homeownership is right for you
In short, you are not disqualified from buying a home with student loans. Yet, it could make it harder to locate a lender willing to accept your DTI, credit score, and down payment. Further, the mortgage may be more expensive with higher interest rates to ensure you’re worth the risk.
You’ll need to be honest about what you can afford if you’re considering homeownership. Review your credit, monthly budget, and what a monthly mortgage payment would do to said budget. Helali says it best: “If the numbers work out and you don’t have to bend over backward, then consider buying. If you’re going to have to squeeze every last penny, you may want to hold off and focus on debt recovery first.”
You’re allowed to dream and want what 74% of U.S. citizens do as well — but make sure you do it on a timeline that works for you.
Header Image Source: (R ARCHITECTURE / Unsplash)
- "Average Student Loan Debt," Education Data Initiative (July 2021)
- "LIFE Millennials and Gen Zers do want to buy homes—they just can’t afford it, even as adults," CNBC (June 2022)
- "FHA Loan Requirements: Downpayment, Credit, Limits and More," NextAdvisor (April 2022)
- "If your federal student loan payments are high compared to your income, you may want to repay your loans under an income-driven repayment plan.," Federal Student Aid