Ready to Buy a Home? Don’t Let Student Loans Hold You Back
Gone are the days of all-night study sessions followed by cold pizza for breakfast. All that's left of your college years are some great memories, and of course, those pesky student loans. As an adult, you know paying off your debt should be a priority, but does that mean you have to put off other goals—like homeownership? Not necessarily. In fact, all it takes is a little discipline and smart decision-making and you could be tackling your student debt from the comfort of your own new home.
The key is to evaluate your current financial situation and be ready to make adjustments if necessary. Here are five questions to think about as you consider making room for a mortgage in your life. If you answer yes to them, it might be a good time to start house-hunting.
Will you qualify for a home loan?
Before you can borrow money to pay for your new home, your lender will want to feel comfortable that you'll be able to pay it back with interest. They tend to focus on three things: income, credit and debt-to-income ratio (DTI).
Believe it or not, sometimes having student debt can have a positive effect on your credit score. Yup, making regular on-time payments can help you establish good credit and demonstrate to lenders that you're a responsible borrower.
That said, lenders will want to make sure you'll have enough money leftover to pay your mortgage after you've made your student loan payments by looking at your DTI. DTI is calculated using your total amount of monthly debt obligations, including things like student loans, car payments, credit cards and mortgage payments, divided by your gross monthly income. And when it comes to DTI, lower is better. In fact, typically a standard loan requires a DTI of 43 percent or lower.
Have you saved (or will you save) enough for a down payment?
A mortgage will typically cover most of the cost of your new home, but you'll also have to pay for some of it with cash. That's called your down payment, and it usually ranges from 5 to 20 percent of the home's purchase price, depending on the type of loan you apply for. So if you've been eyeing a nice little two-bedroom that's listed at $250,000, you can plan on bringing anywhere from $10,000 to $50,000 to closing.
Since that's probably a bit more than you keep in your wallet, you'll want to get started saving as soon as possible. Setting up a direct deposit from your paycheck to your savings account works well for most people, and even a small amount will add up over time. Also remember to budget for closing costs, which you will also need to cover in cash.
Can you make mortgage payments on top of your student loan payments?
So your DTI is below 43 percent and you qualify for a mortgage – but what does that really mean? When lenders calculate your DTI they're not paying attention to how much you spend on clothes, eating out or Uber rides every month. It's your job to determine how much money you want left in your pocket (and in your savings account) after paying your student loans, mortgage and other obligations.
Does your rent cost more than a mortgage?
It's arguable that owning a home is almost always more cost effective than renting. For starters, part of each mortgage payment you make will go toward interest and part will go toward the equity. In other words, you'll continue to pay down the loan and own more of your home. But with renting, no matter how much you pay your landlord you're still just a tenant.
What's more, just like you can deduct your student loan interest, as a homeowner you may be able to deduct the mortgage interest you pay each year from your federal income taxes.
Are you able to reduce your student loan payment?
If your student loans are keeping your DTI too high, don't give up just yet. Be sure to explore all of your options for paying down your debt or reducing your payments. Are you expecting a bonus from work soon that you can use to pay down the balance? Or better yet, your employer may even offer a student loan debt repayment program as part of their benefits package.
Another option is to refinance your loans, or take advantage of one of the repayment options available from the Department of Education. If you're expecting a bump in pay within the next few years, you might want to consider the Graduated Repayment Plan, where your payments would start out low, and then increase every two years until the balance is paid. There's also the Extended Repayment Plan, where payments can be fixed or graduated and spread out over 25 years, bringing down your monthly payment.
To get an idea about which repayment plans you qualify for and how much your new monthly payment will be, check out the Department of Education's Repayment Estimator tool. Once you're ready to take the dive into homeownership, it's time to put that degree to work and start crunching the numbers to make it happen.
Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. Please consult your tax advisor. All calculations and information shown here are for illustrative purposes only. All third parties listed above are for demonstration purposes only and are not affiliated with LendingHome. All views and opinions expressed in this post belong to the individuals referenced. NMLS ID: 1125207 Terms, Privacy & Disclosures. Copyright LendingHome Corporation 2019.