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Having a college degree can help you land a better desirable job, ideally with a higher income. But if you took out loans to finance your education, these will need to be repaid over several years.
If you’re aiming to purchase and own your first home, carrying outstanding student loan debt can make it more challenging to qualify for home loan financing. That’s because lenders want to ensure you’ll be able to repay what you owe on your mortgage as well as other debts.
This article will help you better understand how student loan debt affects your eligibility for a mortgage loan, what your debt-to-income (DTI) ratio is, action steps you can take to reduce your student debt and qualify for a mortgage, and various loan options to consider.
How student loan debt impacts mortgage loan approval
Fact is, it can be challenging to get approved for a mortgage loan if you carry outstanding student loan debt. The reason is simple.
“Mortgage lenders assess your ability to repay a loan. If you are already straddled with hefty student loan debt, they fear you might not be able to manage another loan obligation on top of that,” explains Dennis Shirshikov, head of growth at Awning.com and a finance and economics professor at the City University of New York.
“When lenders assess your loan application, they will carefully consider the percentage of your gross monthly income that goes toward paying your debts. Having high student loan debt can worsen this percentage, making you less appealing to lenders.”
This is like trying to stuff an extra suitcase into an already overflowing trunk – it just makes the journey more complicated, he adds.
“Picture yourself as a juggler, keeping balls in the air. Each ball represents a different kind of debt: credit card, student loan, car loan, etcetera,” Shirshikov continues. “If you have too many balls, it becomes increasingly difficult to keep them up in the air. Similarly, each debt you carry consumes a portion of your income – and the more debt you have, the riskier you appear to lenders.”
The “percentage” discussed above is actually referred to as your debt-to-income (DTI) ratio. It’s an important metric that will determine your creditworthiness and if you get the green light from a mortgage lender.
“To calculate your DTI, you divide your monthly debts – including your estimated mortgage payment as well as student loan debt, credit card debt, auto loan debt, and other forms of debt – by your monthly pre-tax income,” notes Brian Shahwan, a mortgage banker and broker with William Raveis Mortgage in New York City. “Most lenders require your DTI number to be under 43%, although some will allow as high as 50%. To get more preferred interest rates and options across several lenders, you should shoot for a DTI under 43%.”
Personal finance expert Andrew Lokenauth recommends a DTI even lower.
“I would aim for a DTI of 36% or less, if possible,” he says.
Let’s say you earn $5,000 per month and you currently pay $1,500 monthly toward student loans, credit card debt, and car loans. That equates to 30% of your income already committed to debt repayment – even before mortgage loan payments are even factored in.
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Strategies to help qualify for a mortgage loan
The U.S. Department of Education’s COVID-19 relief for student loans – in effect for the past few years – is ending soon. Student loan interest will resume beginning September 1, 2023, and payments will be due starting in October of this year.
So if you’re in the market for a home you’ll need to borrow money to purchase, it’s time to start planning carefully for how you’ll manage your student debt and attract a mortgage lender.
Here are several suggested strategies to improve your odds of mortgage loan approval, especially if you have student loan debt:
- Pay down your debts. The more you can lower your outstanding debt, the lower your DTI ratio will be, and the better your odds of qualifying for a mortgage loan. Experts recommend paying off debts with the highest interest rates first, if possible, “as loans with higher interest rates will rapidly increase your overall balance month over month,” Shahwan says. “However, don’t stress about paying all of your debts off as quickly as possible. You wouldn’t want to use all of your available cash to pay off existing student loans because lenders will need to see enough liquid assets to cover your down payment, closing costs, and reserves. Plus, paying off balances in full and closing accounts can negatively impact your credit score in the short term.” Instead, he recommends continuing to pay your student loans on time every month and consulting closely with a mortgage professional from your chosen lender to discuss if any debts are an issue or not.
- Improve your credit score. One of the biggest criteria a lender will scrutinize is your three-digit FICO score, which can range from 300 to 850: The higher your score, the more likely you will be eligible for the best loan deals with the lowest interest rates and most preferred terms. You can up your score by always paying your bills on time, never missing payments, maintaining a low balance on your credit accounts relative to your credit limits, not applying for new loans or lines of credit, reviewing your three free credit reports and disputing any errors or inaccuracies you spot, and not closing any existing credit accounts.
- Save for a larger down payment. “The more money you can put down upfront, the less you will need to borrow and the more appealing you will look to lenders,” says Shirshikov.
- Increase your income. “Try to get a promotion, second job, or side gig,” advises Lokenauth.
- Get a co-signer on the mortgage loan to improve your DTI ratio.
Mortgage loan options when you have student debt
Even if you have student loan debt, you should be able to qualify for most major loan programs, assuming you meet the loan’s requirements or guidelines for DTI, credit score, loan-to-value ratio, down payment, and other criteria. Explore these loan options:
- Conventional loans. The good news is that conventional loans – offered by private lenders who later sell their loans to Fannie Mae or Freddie Mac – may allow a DTI of up to 50% and a down payment of as little as 3%. But conventional loan lenders often require at least a 620 credit score.
- FHA loans. These government-backed home loans can be had for as little as 3.5% down (with a 580 or higher credit score) or with a credit score as low as 500 (if you make a 10% minimum down payment), but your DTI may need to be 43% or less.
- VA loans. Offered to active duty service members, military veterans, and surviving spouses, a VA loan requires no down payment and no mortgage insurance, but the lender may prefer a DTI no higher than 41%. The US Department of Veterans Affairs doesn’t set a minimum credit score requirement.
- USDA loan. Available to qualified borrowers who purchase a home in an approved rural location, this loan also needs no down payment, but your DTI cannot exceed 41%. Experts recommend having a credit score of 640 or higher.
The bottom line
Not having your student loan debt paid off won’t automatically disqualify you from getting a home loan or affording a property. But it’s smart to explore ways to reduce this debt before applying for a mortgage.
“Overall, focus on improving your financial health – not just to get a mortgage and eliminate your student debt but for overall stability and peace of mind, too,” Shirshikov advises. “Work on increasing your earnings and savings and maintaining a solid credit history as well.”