Experts are divided on whether student debt is affecting the
housing market. A recent study by John Burns Real Estate Consulting estimated
that heavy college debt will reduce real estate sales by 8 percent for this
year.
Meanwhile, the Federal Reserve Bank of New York found that,
for the first time in at least a decade, households with student loan debt are
less likely to have a mortgage than those without student loan debt.
Others disagree and maintain that lower home purchases among
millennials are more due to changing mores and attitudes of the younger
generation.
The math behind the former argument is obvious: More debt
means less money to save for a mortgage down payment and leads to fewer home
purchases. However, that’s not the only thing holding borrowers back.
If you have student loans and want to own a home – whether
in the next month, next year or next decade – you need to manage how your
student loans affect your debt-to-income ratio and overall credit score to
ensure you’ll be approved for a mortgage when the time comes. Here are the main
things to keep in mind.
Your Debt-to-Income Ratio
A debt-to-income ratio is one way lenders measure your
ability to manage and meet your monthly loan payments. If you’re applying for a
mortgage, a lender will calculate your debt-to-income ratio by adding up all
your monthly debt payments, including your expected mortgage amount, and
dividing them by your gross monthly income – the amount you earn before taxes
and other deductions.
Debt payments include mortgages, auto loans, student debt,
credit card debt and any other installment or revolving debt. It does not
include other budget expenses such as utilities. Most lenders will not approve
you for a mortgage if your debt-to-income ratio exceeds 43 percent.
The Role of Your Student Loans
Let’s say you’re a recent college graduate earning $45,473
annually – the average for the college
class of 2014. Your gross monthly income would be about $3,789. You have a car
loan monthly payment of $200 and a credit card payment of another $200. On top
of that, let's say you have $30,000 in student loans, about the average amount
of debt for graduating college seniors. Assuming this is an unsubsidized
Stafford loan at 4.6 percent interest, you'll be left with a monthly payment of
$312.
Now, let's say you’re applying for a home loan of $222,261
with a $1,061 monthly payment – the national average. Your total monthly debt
payments would total $1,773 and your debt-to-income ratio would be around 46
percent, putting you over the 43 percent threshold and potentially out of luck
for buying that particular house.
Options to Manage Your Loans
While your car and credit card payments can’t be adjusted
without refinancing the auto loan or paying down your credit card balance, any
federal student loans have some flexibility.
Using the example above, switching your student loan
repayment plan from standard to graduated would result in a monthly payment of
just $176. That reduces your debt-to-income ratio to 43 percent, potentially
increasing your chances of being approved for the mortgage.
It’s important to recognize that the graduated plan assumes
your salary will rise in the next few years. Your student loan payments start
low with this plan but then accelerate.
The last thing you want is to take on a mortgage that you
can’t afford if your student loan payments rise. If you don’t think your salary
will increase anytime soon, you may want to check out some other repayment
options like income-based plans.
Ways to Elevate Your Credit Score
Student loans can also affect your mortgage approval in that
they are an important factor in your credit score. Paying your student loans on
time each month is an excellent way to build good credit.
A lender will use your credit score to not only evaluate
whether your mortgage should be approved, but also to determine your mortgage’s
interest rate. Borrowers with higher scores are eligible for lower interest
rates and more loan choices, while subprime borrowers face higher interest
rates, less eligibility for different varieties of loans and possibly even
denial of their mortgage request.
Federal student loans are usually reported to credit bureaus
as delinquent after 60 days of no payment; private loans may be classified as delinquent
– or even defaulted – after just one missed payment. If late student debt
payments are dragging your credit score down, contact your student loan holder
to talk about getting your payments back on track.
You can bring your account current by making all the
payments you’ve missed, switching to a different payment plan or temporarily
postponing payment and halting any more damage to your credit report.
If you’ve defaulted on your student loan, you can
rehabilitate your loan back to good standing and remove the default from your
credit history – though the delinquency will stay.
If you are planning to take on more study loan and you
want to buy a home soon after you leave college, stick to federal student loans
and avoid private loans if possible. The flexibility to lower your monthly
payments can be crucial to maintaining a healthy debt-to-income ratio and
credit score.
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