Applying for one loan while paying off another is always difficult. Lenders approve borrowers with minimal debt because taking out a second loan increases the risk of one of the loans defaulting – or both.
This consideration becomes even more important in the context of taking out a mortgage and repaying your student grantsas these are two of the main types of debt most people will encounter. In addition to the challenges of getting approval, student loans can also make it harder to save for important things like a down payment, closing costs, and moving costs.
Here’s a more detailed look at how having student loans can affect buying a home and what you can do to minimize these consequences.
How Student Loans Affect Home Buying
There are a few different ways that your student loans affect your finances, including your debt to income ratio, savings potential, and credit score. All of this can help you buy a home.
Student loans add to your debt-to-income ratio
Lenders use the debt-income (DTI) ratio to decide how big your mortgage is. DTI includes all of your monthly debt payments divided by your gross monthly income.
Most lenders require your total DTI ratio, including your future mortgage payment, to be 43 percent or less. If you have a high student loan, your DTI can get past the 43 percent threshold, making it more difficult to qualify for the kind of home you want.
Be aware that federal loan borrowers have a Income-Based Amortization Plan (IDR) will have to use the 10-year standard payment plan when calculating their DTI, as most mortgage lenders don’t use the IDR figure when calculating DTI. Even if you’ve always had an IDR repayment plan, they will still use the 10-year standard payment for their calculations.
You can find the standard payment amount on your monthly student loan statement.
Paying off student loans is detrimental to your ability to save
Buying a home requires a down payment, usually several thousand dollars in total. Borrowers who have paid off their student loan may find it difficult to save for a down payment on top of their monthly student loan bills, which can easily slow down their ability to buy a home.
Student loan payment history plays a role in your credit score
Payment history is the most crucial factor in your creditworthiness, accounting for 35 percent of the total score. Borrowers with a timely track record will see their score increase, while those who paid late on their student loan will see a lower score. Consumers who have defaulted on loans will also see a dip in their score.
Mortgage lenders weigh your credit score heavily when determining your approval odds and your interest rate. If you’ve had trouble paying off your student loans on time, your chances of qualifying for a mortgage could be hurt.
The good news for borrowers? Credit bureaus generally give more weight to recent mistakes than previous mistakes, which means that any mistakes you made at the beginning of your student loan repayment path will be less significant over time.
Ways to Buy a Home Despite Student Loan Debt
Many people who buy a house also have a student loan. A few ways to manage your student loan while buying a home include:
- To apply for down payment scholarships: Local and national deposit support programs can provide down payment subsidies to home starters. These scholarships will cover some or all of the down payment. Borrowers usually need a credit score of 600 or more.
- Look at 0 percent down payment loans: Former and current service representatives are eligible VA loans, which does not require a deposit. Anyone who buys a house in the countryside can also buy one USDA loan, which has a 0 percent deposit.
- Lower your DTI: Because the DTI only takes into account your monthly debt payments and not the total amount remaining, you can lower the DTI by paying off some small debts quickly. If you can make additional payments on one of your smaller loans and pay it off, you may qualify for a larger mortgage.
The Best Ways To Pay Off Your Student Loans
If you want to minimize your debt by paying off your student loans, you have a few ways to make that process easier.
Refinance to a lower interest rate
Borrowers with high-interest loans should consider refinancing to a lower interest rateRefinancing to a lower rate will save you interest and potentially lower your DTI, making it easier to qualify for a mortgage.
Let’s say you owe $ 80,000 in student loans with an interest rate of 6.8 percent and a term of 10 years. Make use of one student loan calculator, you can see that your monthly payment is $ 920 and you pay a total of $ 30,477 in interest. If you refinance to a 10-year term at a 4 percent interest rate, your payments will drop to $ 810 per month, which lowers your DTI. You also save a total of $ 13,282 in interest payments.
If you choose to refinance to a term longer than your original one, your DTI will also decrease significantly as your monthly payments will be lower. Since student loans cannot have prepayment penalties, you can pay extra on your loans and pay them back faster.
Those with federal loans should be aware that refinancing will take away benefits such as extended deferment or forbearance, income-driven repayment, and loan forgiveness. Borrowers with private loans will experience few disadvantages.
Work towards forgiveness
Teachers, nurses, and physicians working in low-income areas may qualify for state and local forgiveness programs. Look for your state and local forgiveness programs to see what’s available.
Find an employer who will pay back student loans
More and more companies are offering student loan repayment as employee benefits. Some employers will match your student loan payments or offer their own repayment program. Contact your HR manager to find out what options are available.
Set up automatic payments
Many federal and private loan managers offer interest deductions for borrowers who have automatic payments set, usually around a 0.25 percent discount. This is an easy way to lower your interest and it ensures that you always pay on time. As a bonus, this history of on-time payments will boost your credit score.
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