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Mar 09, 2021 | By Adebayo Adeagbo
Buying a Home with Student Loan Debt

Buying a Home with Student Loan Debt

Can you buy a home when you have student loans? In short, yes!

Many people think that it is not possible to qualify for a mortgage when you have student loans.

However, the reality is that having a college degree increases your chances of becoming a homeowner - even if you had to take out student loans.

 In fact, about 30% of current homeowners have student loans.

While your existing debt might mean starting out in a smaller house or condo at first, it is possible to buy a home while you're still paying off your student loans.

In fact, homeownership can actually help some people to pay off their student loan balance more quickly. This is because homeownership helps you to build financial stability and wealth over time.

In this article, we'll look into some common concerns that people with student loans have about homeownership.

In addition to debunking myths and misconceptions, you'll also learn about ways to get help with a down payment and compensate for less-than-great credit.

We'll also look into how lenders account for student loan payments when you apply for a loan. Finally, you can learn about how using a mortgage to refinance student loans works.

The biggest thing that trips people up when it comes to buying a home is a lack of knowledge. Well-informed is well-armed. At Coole Home, we want to help eliminate the fear of the unknown that keeps so many people from considering buying a home.

Saving for a down payment when you have student loans

Many young people, especially those with student loan debt, fear that homeownership will be forever out of reach. They worry that they will never be able to save enough money to make a down payment. However, people often overestimate how much of a down payment they need.

There are several government-backed loan programs that enable people to buy homes without having to put a lot of money down. In fact, for some programs, such as the VA home loan and USDA home loans, you don't have to make a down payment at all. Because the government guarantees the loan, lenders will still offer competitive interest rates without asking for a large down payment.  

FHA home loans are another kind of government-backed loan. The standard down payment on FHA loans is only 3.5%.

There are also conventional loans (non-government) that have a down payment as low as 3%.

In addition to low-down payment loans, there are also down payment assistance programs. Many of these programs are designed to help first-time homebuyers overcome the down payment hurdle.

It is even possible to get grants to help you make your down payment. With a grant, your down payment assistance can be forgiven if you stay current on your mortgage for a set period of time.

What's more, the FHA has a down payment assistance program. So, you can combine the low down payments on FHA loans with grants to help you meet the remaining costs.

Another way to get a lower down payment is to get a smaller home. A starter home or condo can be more affordable. It's also a way to start building equity right away - and make it easier to qualify for your next mortgage later on.

How can I afford the closing costs?

In addition to the down payment, it's common to feel overwhelmed when saving for the closing costs on a mortgage. However, here is one way to reduce these costs.

Seller concessions. The seller may agree to pay some or all of the closing costs. This is where working with an experienced real estate agent and loan officer pays off - they will make sure the offer and the loan is properly structured.

Is my credit really good enough to get a mortgage?

If you're worried about whether your credit score will keep you from being able to get a mortgage, you're definitely not alone. Fannie Mae data suggests that over 40% of renters ages 25-44 consider credit to be the biggest obstacle to getting a mortgage.

However, does this worry match the reality of the situation?

According to Experian, the average FICO score for Americans ages 20-29 is 662; for ages 30-39, it jumps to 673. This means that, on average, people are in pretty good shape with their credit. So, the average person under 40 has a good enough credit score to qualify for a mortgage.

This is one place where student loan payments can actually help. By paying off your student loans, you are building a credit history. Keeping current with your student loan isn't just paying down the balance, it's also improving your credit score.

There are options for people with credit scores as low as 620. All of the government-backed home loan programs are open to people with credit scores as low as 620.

In addition, it is definitely possible to build or establish credit before getting a mortgage. If you are looking to boost your credit score, here are some things to keep in mind

  • The most important thing is to make payments on-time; a year of on-time payments can make a huge difference.
  • Don't close any lines of credit without checking with a financial advisor - this can impact your credit.
  • Similarly, don't apply for new credit
  • If you have no credit history (which is not the same as having bad credit), the FHA and VA loan programs provide some alternate ways to document credit.

How much does owning a home really cost?

Occasionally, new homeowners are surprised by the costs that come along with homeownership. In addition to mortgage payments, there are property taxes, insurance premiums, and upkeep costs. However, despite these costs, owning a home is still cheaper than renting. What matters is being informed, so you can plan for them ahead of time - and chose a home that is right for you.

PITI

The good news is that your loan officer will break down the tax and insurance costs for you. When you get a loan offer, you'll see a column labeled "PITI," which stands for "principal-interest-taxes-insurance." This figure gives you an idea of what you'll be paying each month once everything is added up.

One thing to be careful of, though, is understanding that the interest on an adjustable rate mortgage will not stay the same over the course of the loan. Because of this, you can never compare the interest on fixed-rate mortgages to the interest on adjustable-rate mortgages.

Maintenance

The biggest difference between owning and renting is that a homeowner has to pay for all the maintenance costs. But do they really? Condos provide a great option for people who don't want the hassle of dealing with their home's upkeep. Instead, you can rely on the Condo Association to keep things in working order.

Another option, for people who are more worried about unexpected repair costs, is to get a home warranty. In fact, sellers sometimes offer these policies as an incentive for the buyer. A home warranty covers non-structural repairs. If you're buying an old home and worried about some of the appliances, this can be a way to lessen the risk.

How do my student loans affect my Debt-to-Income Ratio?

It is true that student loan debt has an effect on how your mortgage application is evaluated. The biggest stumbling block for people with student loans is often not their credit but their Debt-to-Income ratio (also known as DTI).

In essence, DTI is your monthly debt (credit card, car payment, student loan payments, etc.) divided by your monthly income. The most common reason that mortgage applications are rejected is due to a high DTI, and this is one area where student loans can make it particularly challenging to get a mortgage.

However, guidelines from Fannie Mae are working to make homeownership more accessible to a generation still paying off their student loans. Thanks to these guidelines, lenders look at student loans a little bit differently than other kinds of debt - especially with regard to how they evaluate deferred payments.

How do lenders account for my student loan debt?

Conventional

Conventional lenders can use the monthly payment on your student loan statement as part of calculating  your DTI. In order for them to do this, you will need documentation showing not just your monthly payment but also when your loan will be paid off.

If your loans are deferred or in forbearance, they will use 1% of the outstanding balance. These loans generally want to see a DTI ratio around 41%. However, some lenders will accept a DTI as high as 48%, if you have a high enough credit score.

FHA

FHA will generally use 1% of the loan balance to calculate your monthly payment. In addition, they want to see a DTI of 43% or lower. In some cases, FHA will go up to a 50% DTI. However, you can use your actual monthly payment if you have documentation to show that you will pay off the loan in full over the course of its term.

USDA

For USDA home loans, which can be used to purchase or build a home in a rural area, you can use your actual monthly payment in the debt calculation. In order to do so, the payment, interest, and repayment terms bust be fixed.

For Income Based Repayment, deferred loans, and other non-fixed loans, your monthly debt obligation will be set at 1% of the loan balance.

VA

First of all, the VA has many programs in place to help Veterans pay off their student loans. Among these programs include employment opportunities that offer student loan forgiveness. Furthermore, the VA has some of the most forgiving guidelines for how student loan debt is used to evaluate you for a VA home loan.

The VA guidelines are as follows:

 If you have documentation to show that your student loan will be deferred at least 12 months beyond the closing date, then the lender does not have to consider a monthly payment.

   For loans that you are currently repaying, or that you will start repaying within 12 months of closing, the first thing the VA either use your actual monthly payment or 5% of the outstanding balance divided by 12 months, whichever is greater.

For example, if you have a balance of $25,000, the VA calculations get monthly payment of $104.17. If your monthly payment is above that number, they will use the actual monthly payment. If it is lower, they will use their figure. What this boils down to is that your VA loan DTI is much more likely to reflect your actual, current repayments than the DTI calculated for other loans.

Physician Mortgages

Too few people know that there are loans specifically designed for people in professions that often have high student loan bills. For example, there are physician mortgages. These loans are offered only to doctors and often don't include your student loans in your DTI. That means your medical debt won't keep you from getting a mortgage. In addition, they can have down payments as low as 5%.

Refinancing: an unexpected benefit

One particular benefit for homeowners with student loans is that they have the option to refinance their mortgage to pay the student loans off, all in one go. This is a particularly good option for people who have post-graduate loans, which often have much higher interest rates.

Additionally, you can deduct a much larger part of your mortgage interest on your tax returns.

Finally, a mortgage can be easier to deal with if you run into financial trouble. Unlike student loans, you can file bankruptcy on a mortgage. In addition, the total monthly payment after refinancing could be lower than what you were paying previously. This means it could be easier to manage your finances.

In order to do a student loan refinance and benefit from the Fannie Mae guidelines, you have to be ready to pay off the whole amount. Basically, when you go down this route, your student loans are paid off in full at closing when you agree to the new rate and term on your mortgage.

Don't let student debt stop you from thinking about homeownership

While it's true that student loans can sometimes be an obstacle to owning a home, that doesn't mean it's impossible. With a strong understanding of the mortgage process, you can find a program that works for your financial situation.

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