Although many millennials and older Americans worry their high debt makes homeownership off-limits, buying a house with $100k, $200k, and $300k or more in student loan debt is possible.
Student loans affect your ability to get a mortgage, but no different from other debt types, including car loans and credit card debt. Mortgage lenders will review your debts, income, and credit history to determine if you can afford the monthly mortgage payment. So long as your income allows you to cover your monthly student loan payments and other bills, getting a home loan is within reach — especially since the Federal Housing Administration eliminated its 1% rule for student loan balances.
Nonetheless, there are two groups of people whose student loan debt stands in the way of becoming first-time homebuyers:
- Borrowers with high private student loan balances
- Parents with high incomes who borrowed federal student loans for their children
For everyone else, having student debt doesn’t mean you’ll never be able to get a mortgage. Ahead, here's what you should know as you explore your options.
- You can get approved for a mortgage with high student loan debt — especially if your debt is mostly federal.
- Lenders use your monthly student loan payment to calculate your debt-to-income (DTI) ratio.
- Your DTI typically needs to stay under 43% to get a mortgage loan.
- Loan programs treat deferment, forbearance, interest-only, and income-driven repayment plans differently when calculating DTI.
How student loans affect buying a house
Student loans make getting a new home more difficult by:
- Increasing your DTI ratio. Borrowers with higher loan balances will have higher minimum monthly payment amounts due on their student loans. Higher monthly payment amounts will increase your monthly debt-to-income ratio percentage, which may limit the mortgage you’re approved for. Federal student loan borrowers can decrease their DTI by entering into a repayment plan based on their income (e.g., IBR).
- Making it harder to save. Paying student loans each month slows your efforts to improve your overall personal finances through saving, especially if you have private loans and aren't eligble for student loan repayment plans based on income.
- Affecting your credit score. Whether you owe $100k, $200k, or $300k, your student loan balance doesn’t lower your score. What hurts your credit score is delinquency and student loan defaults — especially if you have more than one loan. Each loan will add derogatory information to your credit report. A lower score will increase the mortgage rate you qualify for.
Learn More: Marrying Someone With Student Loan Debt
Can student loans prevent you from buying a house?
Student loans can prevent you from buying a house if you’re in default or if a significant portion of your income goes to paying back your loans.
Loans in default. Student loans can prevent you from buying a house if you default on a federal student loan. When that happens, the default status is automatically placed in the federal government’s credit reporting system, CAIVRS. Until you clear that system by getting out of default, you’re ineligible for an FHA, VA, or USDA Loan.
High student loan debt. Borrowers with high private student loan balances or high income and Parent PLUS Loans often have trouble qualifying for a home loan because their monthly student loan payments raise their DTI ratio. Refinancing, asking your servicer for a more affordable payment plan, or negotiating a student loan payoff can help with private student loans. The best repayment option for Parent PLUS Loans will likely be switching to the income-contingent repayment plan or the Extended or Graduated plans.
A step-by-step guide to buying a house with student loan debt
You can maximize your chances of qualifying for a mortgage with high student loan debt if you:
Step 1: Raise your credit score
Your credit score plays an outsized role in your ability to get a mortgage with high-student loan debt. A higher score not only allows you to qualify for a lower down payment and a lower interest rate, but it also allows you to qualify for mortgage options that limit the impact your student loans have on your DTI ratio (e.g., Fannie Mae and Freddie Mac backed conventional home loans).
Paying your student loans on time consistently and requesting alternative repayment options when you can’t is one thing you can do to increase your credit score. Other things you can do to raise your score are to:
- Pay bills on time. A single missed payment can crush your score. So before you’re late on a bill, ask for a deferment or forbearance.
- Lower your credit utilization rate. Ideally, you’ll want to use less than 30% of your available credit on each credit card you have.
- Avoid new credit lines. Stop applying for new credit and personal loans within 1-2 years before buying a home.
- Keep old accounts open. Older accounts help raise your credit score. So avoid closing credit card accounts with zero balances.
Pro-tip. Tools like Credit Karma are great for monitoring changes to your credit report. But they don’t provide a reliable credit score. When your lender Be prepared for the credit score your lender has for you to be about 20 to 30 points less than your Credit Karma score (or your FICO score, for that matter.)
Step 2: Improve your DTI ratio
There are two parts to DTI that you’ll need to worry about, front-end and back-end.
Front-end DTI: The front-end ratio is your projected monthly mortgage payments divided by your gross monthly income (income before taxes). Your projected mortgage payment is your principal, interest payments, taxes, and insurance (PITI). The acceptable front-end DTI ratio will depend on the lender. For example, you should expect a ratio of about 28% for conventional loans. But FHA Loans allow for a maximum front-end ratio of 31%.
Back-end DTI: The back-end ratio accounts for all of your debt obligations compared to your income. Your lender will calculate this ratio by first adding your monthly debt payments to your housing expenses. Your monthly debt payments include child support, auto loan, credit cards, student loans, etc. Once your lender totals your monthly expenses, they’ll divide it by your gross monthly income.
Back-end DTI Limits
- Conventional mortgage - Fannie Mae: uses 36% for manually underwritten loans, 45% if you meet certain credit and down payment requirements, and 50% for certain loans underwritten by software.
- Conventional mortgage - Freddie Mac: accepts 33 to 36% for most loans and 45% on a case-by-case basis.
- FHA Loans: allows up to 43% for most loans and 45% for FHA’s Energy Efficient Homes program.
- VA Home Loans: accepts up to 41%.
- USDA Home Loans: accepts up to 41%.
Step 3: Keep a steady job history
As part of your home loan application process, your lender will not only look at your front-end and back-end DTI ratios, credit report, assets, available down payment, and income, but they’ll also look at your work history. Many lenders will require two years of employment history from all income sources.
If you’re a recent college graduate, consider holding off on buying a home until you reach that two-year mark. The same is true if you’ve picked up a side-gig to increase your monthly income.
Step 4: Work with a good lender
Not all lenders and mortgage brokers are created equal. Some are better than others when navigating the student loan guidelines under the different homeowner programs. Ideally, you’d want to work with a lender:
- who has recently helped borrowers with high student loan debt and moderate-income get into a home; and
- who looks to provide solutions to overcoming your student loan debt in the home buying process rather than leaving you to solve things yourself.
Don’t rely solely on your real estate agent to connect you with a lender. Check with friends who have student loan debt and recently bought a home to see who they worked with and how their experience went.
Watch this interview with senior mortgage officer Dennis Tate to get an idea of what to look for in choosing your lender/mortgage broker.
Step 5: Check out first-time homebuyer programs
In addition to down payment assistance programs, take advantage of one of the many first-time homebuyer mortgage programs offered by federal and state-based agencies. These programs offer low-interest rates, and many have no down payment requirement, which can be a huge boost if you’re dealing with a heavy student loan burden.
Federal first-time home buyer options
- VA Loans: no down payment required. Open to military members and veterans.
- USDA Loans: no down payment required. Open to home buyers willing to live in rural areas.
- Good Neighbor Next Door Program: down payment as low as $100. Open to teachers, police officers, firefighters, and EMTs.
State first-time home buyer options
States have created first-time homebuyer programs and downpayment assistance offerings for their residents. Many of these programs help with closing costs and other expenses.
In addition, there are also state-backed loan programs that help eligible participants lower their interest rate and monthly payment, both of which can save you money over the life of the mortgage.
The Department of Housing and Urban Development (HUD) maintains a list of state-specific resources at HUD.gov.
Step 6: Refinance private student loan debt
If your private student loans have a high-interest rate and short repayment period (10 years or less), refinancing into a new loan lower interest rate and longer repayment term may help lower your DTI.
Refinancing federal student loan debt is also an option. But if you work for the government or a nonprofit and are pursuing the Public Service Loan Forgiveness Program, refinancing may not be in your best interest. You’d lose eligibility for the PSLF Program.
You can check student loan refinancing options at credible.com.
Step 7: Get down payment assistance
While having a down payment of 20% of the purchase price is great (you can avoid private mortgage insurance (PMI)), most first-time homebuyers cannot put that much down. Don’t worry. You’re not alone.
Many first-time homebuyers with student loan debt haven’t been able to save for a significant down payment. They’ve only recently begun earning more income, and they’ve been paying back their student loan debt.
Thankfully, many down payment assistance programs help cover both the down payment and closing costs on your loan.
The assistance will usually be:
- A down payment grant. Grants are interest-free and don’t need to be repaid.
- Forgivable second mortgages. Second mortgages can be forgivable loans on top of the ones used to finance your house. They’re forgiven if you live in the home for a certain number of years.
- Traditional second mortgage. A second mortgage can help by giving you a low-interest loan. This loan will need to be paid off monthly, just as your primary mortgage does.
- Matched savings programs. A matched savings program requires saving funds in a dedicated down payment savings account. The entity offering the program will match those funds up to a certain amount.
These programs typically have specific eligibility requirements. You may need to:
- be a first-time homebuyer
- have income below a certain amount
- serve in the military or be a veteran
- work in public service (e.g., teacher, police officer, firefighter, etc.)
- complete a homebuyer education course (e.g., NACA mortgage)
- save a certain amount of money each month
Learn more about these local programs by asking your bank/credit union, realtor, mortgage broker, lender, etc.
8. Get a co-borrower
A co-borrower applies for the mortgage loan together with you. Usually, your co-borrower will be a spouse or a life partner. But it could also be a friend or family member.
The advantage of adding a co-borrower to the loan is that both of your incomes and credit profiles are factored into the application.
Depending on their income and credit history, you may be able to qualify for a higher loan amount, lower interest rate, and lower required down payment. Also, the overall loan approval process may be easier.
Keep in mind if your co-borrower also has significant student loan debt and other monthly obligations, adding them to your application may hurt your application.
Need help lowering your student loan payment to buy a home?
When you’re trying to become a homeowner and have high student loan debt, it helps to have someone in your corner who understands each mortgage program's guidelines and the options available to modify your payment terms.
I can help you take the steps necessary to help squeeze your student loans into your DTI ratio. Schedule a free 10-minute call with me today. We’ll go over possible options and alternatives available to you.