Don’t let student loans hold you back
Lenders determine your mortgage eligibility and approved loan amount through your debt-to-income (DTI) ratio.
Since student loan payments increase your DTI, you might have concerns about qualifying for a mortgage. But lenders consider other factors too. So even though student loan debt can take a big chunk of your monthly income, it’s still possible to get a home loan.
However, there are tricks to help you pay them off faster and certain loan types may be better for you.
Is buying a home with student loan debt possible?
Student debt — as well as any other type of debt — increases your DTI ratio, which can present a unique challenge when buying a home.
DTI compares your obligated payments to your income. It’s expressed as a percentage and calculated by dividing your total monthly debt payments by your gross monthly income. For example, if your student loan, car loan, and credit card payments total $1,500 a month, and you have a gross monthly income of $5,000, your DTI is 30%.
Lenders use this ratio to assess your ability to take on additional debt, and they generally prefer a DTI below 43%.
A high DTI means you’re already using a large portion of your income to pay off debts, which can make it harder to manage other important expenses, such as a mortgage.
If student loan payments significantly increase your DTI ratio, you might qualify for a much smaller mortgage, or you might not qualify at all.
Even so, it’s not always necessary to pay off a student loan before applying for a mortgage—especially when your income can support both obligations.
What kind of mortgage can I qualify for?
Different loans have different DTI requirements, so getting a mortgage with student debt is easier under certain programs. Here’s what to expect from four common loan types.
These non-government loans offered by private lenders (banks, credit unions, mortgage companies) generally have stricter DTI requirements. Some lenders prefer a DTI ratio up to 36% for conventional loans, although others may allow a higher ratio (up to 45%) when a borrower has a strong credit file.
These loans, insured by the Federal Housing Administration, have more flexible requirements. They allow lower down payments and lower credit scores, as well as a higher DTI ratio compared to conventional loans. The maximum allowable DTI ratio for an FHA loan is typically 43%, although some lenders may approve loans with a ratio up to 50%.
These loans insured by the Department of Veterans Affairs are available to eligible veterans, active-duty service members, and select surviving spouses. These loans offer attractive benefits, including no money down. Additionally, VA loans have flexible DTI ratios, allowing up to 41%.
These loans are insured by the U.S. Department of Agriculture and available to low-to-moderate-income borrowers who buy properties in eligible rural areas. These loans offer 100% financing and generally require a maximum DTI ratio of 41%.
How to improve your DTI
Reducing your DTI ratio can improve your overall financial picture.
This makes you a more attractive borrower, which increases your chances of getting approved and for a preferred mortgage rate. Tips to improve DTI include:
- Consider ways to boost your income, such as taking on a part-time job or freelance work. A higher income lowers your DTI ratio because you’ll have more money to cover your debts.
- Pay down existing debts (including student loans) to significantly improve your DTI ratio. Make extra payments when possible, and avoid taking on new debt — such as car loans, personal loans, and credit card debt.
- Review your monthly expenses to see where you can reduce spending. After trimming unnecessary expenses, redirect those funds to debt repayment.
- Increase your down payment to lower your mortgage amount and potentially improve your DTI ratio.
- Explore refinancing options to potentially lower your existing monthly debt payments.
Ways to pay off student loans faster
Even though it’s not always necessary to pay off a student loan before applying for a mortgage, getting rid of this balance could make the process easier.
Having less debt compared to your income increases the likelihood of an approval, and you can potentially qualify for a larger loan.
Also, paying off a student loan can improve your credit score. This can help you get a better interest rate, which saves money in the long run.
Strategies to pay off a student loan faster include:
Make extra payments: Paying more than the minimum each month can reduce the principal balance faster and you’ll owe less interest over time. Allocate windfalls to your student loan, such as a work bonus, tax refund, or gift money.
Explore loan consolidation: Consolidating your student loans can simplify repayment. This involves combining multiple loans into a single loan, often resulting in a lower interest rate and lower monthly payment.
One option is the Federal Direct Consolidation Loan which combines all your federal student loans into a single loan with a fixed interest rate. You can consolidate private student loans by refinancing with a private lender.
Use home equity to pay off a student loan: Another option is using a home equity loan or home equity line of credit (HELOC) to consolidate student debt. Both options allow you to borrow against the equity in your home. Understand, however, this involves converting unsecured debt (student loans) into a secured debt (home acts as collateral). Although you can get a lower rate and flexible repayment terms, there’s the risk of foreclosure if you can’t repay funds.
Seek employer assistance: Some employers offer student loan repayment assistance programs as part of their benefits package.
Research eligibility for federal loan forgiveness programs. Public Service Loan Forgiveness or income-driven repayment plans can potentially reduce your loan balance or cap monthly payments based on your income.
The bottom line
Although student loans can create some challenges when applying for a mortgage, they’re not always a roadblock to homeownership.
Buying a home is possible with the right approach — and when you’re proactive. This can include exploring different loan programs (particularly those with flexible DTI requirements) and improving your DTI ratio to ultimately make it easier to qualify with favorable terms.
If you’re ready to see what you can get approved for with student debt, reach out to a local mortgage professional today.