Applying for one loan while you’re still paying off another is always tricky. Lenders like to approve borrowers with minimal debt, because taking on a second loan payment increases the risk of defaulting on one of the loans — or both.
That consideration becomes even more important in the context of taking on a mortgage while paying back your student loans, since these are two of the most significant forms of debt most people will encounter. Beyond the challenges of getting approved, student loans can also make it harder to save for important things like a down payment, closing costs and moving expenses.
Here’s a more detailed breakdown of how having student loans can affect buying a house and what you can do to minimize these consequences.
How student loans affect buying a house
There are a few different ways your student loans affect your finances, including your debt-to-income ratio, savings potential and credit score. All of these could contribute to your ability to buy a house.
Student loans add to your debt-to-income ratio
Lenders use the debt-to-income (DTI) ratio to decide how large of a mortgage to approve you for. DTI includes all of your monthly debt payments divided by your monthly gross income.
Most lenders require your total DTI ratio, including your prospective mortgage payment, to be 43 percent or less. Having a high student loan payment could push your DTI past the 43 percent threshold, making it harder to qualify for the kind of house you want.
Keep in mind that federal loan borrowers with an income-driven repayment (IDR) plan will need to use the 10-year standard payment plan when calculating their DTI, as most mortgage lenders do not use the IDR figure when calculating DTI. Even if you’ve always been on an IDR repayment plan, they will still use the 10-year standard payment for their calculations.
You can find the standard payment amount listed on your monthly student loan statement.
Student loan payments hurt your ability to build savings
Buying a house requires an upfront down payment, usually totalling multiple thousands of dollars. Borrowers with student loan payments may find it difficult to save for a down payment on top of their monthly student loan bills, which can easily delay their ability to buy a house.
Student loan payment history factors into your credit score
Payment history is the most crucial factor in your credit score, accounting for 35 percent of the total score. Borrowers with an on-time track record will see their score increase, while those who have made late payments on their student loans will see a reduced score. Consumers who have loans in default will also see a dip in their score.
Mortgage lenders heavily weigh your credit score when determining your approval chances and your interest rate. If you’ve had trouble paying off your student loans on time, your chances at qualifying for a mortgage could be hurt.
The good news for borrowers? Credit bureaus generally give more weight to recent mistakes over past ones, meaning any mistakes you made at the beginning of your student loan repayment journey will have less significance over time.
Ways to buy a house despite student loan debt
Plenty of people who buy a house also have student loan debt. A few ways to manage your student loan debt while buying a house include:
- Apply for down payment grants: Local and national down payment assistance programs can provide down payment grants to first-time home buyers. These grants will cover part or all of your down payment. Borrowers usually need a credit score of 600 or more.
- Look into 0 percent down payment loans: Former and current service members are eligible for VA loans, which do not require a down payment. Those who buy homes in rural areas can also take out a USDA loan, which has a 0 percent down payment.
- Decrease your DTI: Because the DTI only factors in your monthly debt payments and not the total remaining amount, you can decrease the DTI by paying off some small debts quickly. If you can put extra payments toward one of your smaller loans and pay it off, you may be eligible for a larger mortgage.
Best ways to pay down your student loans
If you’re looking to minimize your debt by paying off your student loans, you have a few avenues to make that process easier.
Refinance to a lower interest rate
Borrowers with high-interest-rate loans should consider refinancing to a lower interest rate. Refinancing to a lower rate will save you interest and possibly decrease your DTI, making it easier to qualify for a mortgage.
Let’s say you owe $80,000 in student loans with a 6.8 percent interest rate and a 10-year term. Using a student loan calculator, you can see that your monthly payment is $920, and you’ll pay $30,477 in interest overall. If you refinance to a 10-year term with a 4 percent interest rate, your payments drop to $810 a month, which lowers your DTI. You’ll also save $13,282 total in interest payments.
If you choose to refinance to a term longer than your initial one, your DTI will also decrease substantially, since your monthly payments will be lower. Because student loans cannot have prepayment penalties, you can pay extra on your loans and repay them faster.
Those with federal loans should be aware that refinancing will remove benefits like extended deferment or forbearance, income-driven repayment and loan forgiveness. Borrowers with private loans will see few downsides.
Work toward forgiveness
Borrowers with federal loans may be eligible for loan forgiveness. Public Service Loan Forgiveness (PSLF) requires that you make 10 years’ worth of payments before having the remaining loan balance forgiven.
Teachers, nurses and doctors who work in low-income areas may be eligible for state and local forgiveness programs. Search for your state and local forgiveness programs to see what’s available.
Find an employer that repays student loans
More and more companies are offering student loan repayment as an employee benefit. Some employers will match your student loan payments or offer their own repayment program. Check with your HR manager to see what options may be available.
Set up automatic payments
Many federal and private loan servicers provide an interest rate deduction for borrowers who set up automatic payments, usually around a 0.25 percent discount. This is an easy way to lower your interest rate, and it ensures that you’ll always pay on time. As a bonus, this history of on-time payments will increase your credit score.