The majority of millennials don’t own a home — and many say their student loans are a major reason for that. According to a 2019 survey from Bankrate, 61 percent of millennials don’t yet own a home, and nearly a quarter of them say student loan debt is what’s holding them back.
Data from the Institute for College Access and Success shows that 62 percent of college graduates financed their higher education with loans, and as of 2019, the average balance was $28,950. As of the second quarter of 2021, combined student loan debt amounted to $1.57 trillion, according to the New York Federal Reserve.
This debt holds back potential homebuyers in two major ways. First, it raises a prospective homebuyer’s debt-to-income ratio, which makes it more difficult to secure a mortgage. Second, it can make it harder to save for a down payment.
Despite those obstacles though, student loan debt doesn’t automatically preclude you from buying a house. While it does make the process more challenging, you can become a homeowner with student debt. If you’re looking to buy your first house, but student loan debts are holding you back, this guide can help you navigate the process and come out on top.
Step 1: Improve your debt-to-income ratio
One of the best things you can do to improve your chances of getting a mortgage loan is to lower your debt-to-income ratio. Your debt-to-income ratio (or DTI) is one of the most important factors a lender will look at when evaluating your application. They want to ensure you’ll be able to afford your new mortgage payment while also staying current on all your existing debts, student loans included.
For most mortgage loans, you can’t have a DTI ratio higher than 28 percent going into your application on the front-end in order to be considered a good candidate. On the back-end, which includes your estimated mortgage and housing expense, 36 percent is the maximum for most conventional loans. If you don’t fall under this threshold, there are a few things you can do to improve it:
- Pay down your debts as much as possible. Work on whittling down your student loan debts, credit card debts and other balances. Use your tax refunds, holiday bonuses or any extra funds you have to make a dent. Even a small reduction in balances can help put the percentages in your favor.
- Increase your income. If you’ve been at your job a while, you may be able to ask for a raise. If not, a second job, side gig or freelance work can help supplement your income and improve your DTI.
- Refinance or consolidate your student loans. Doing this may allow you to lower your monthly payment and the interest you’ll pay over the life of the loan. That will cut your monthly budget and over the long term will improve your DTI in the process.
- Enroll in an income-based repayment plan. Income-driven repayment plans allow you to lower your monthly student loan payments to align with your current income level. These typically allow you to make payments as low as 10 to 15 percent of your monthly income, and can ease some pressure on your budget.
Don’t know what your current DTI is? Use our debt-to-income ratio calculator to get an idea.
Step 2: Increase your credit score
Your credit score also plays a big role in your mortgage application, because lenders use it to evaluate how risky you are as a borrower. A higher score will typically mean an easier approval process and, more importantly, a lower interest rate on your loan.
Making consistent, on-time student loan payments is a good way to build credit and increase your score. You can also:
- Lower your credit utilization rate. Your credit utilization rate is essentially how much of your total available credit you’re utilizing. The less you’re using, the better it is for your score. Credit utilization accounts for 30 percent of your total score, and the easiest way to lower your rate is to pay down outstanding debts.
- Pay your bills on time. Payment history is another 35 percent of your score, so make sure to pay every bill (credit cards, loans, even your gym bill) on time, every time. Set up autopay if you need to, as late payments can send your score plummeting.
- Keep paid-off accounts open. The length of your credit history matters, too, accounting for 15 percent of your score. Leaving long-standing accounts open (even once paid off) can help you in this department.
- Avoid new credit lines. Don’t apply for any new credit cards or loans as you prepare to buy a home. These require hard credit inquiries, which can have a negative impact on your score.
Finally, make sure to check your credit report often. If you spot an error or miscalculation, report it to the credit bureau immediately to get it remedied.
Step 3: Get preapproved for a mortgage before you house hunt
Shopping for that dream house is definitely the most exciting part of the process, but before you can start, you should get preapproved for your mortgage loan. A preapproval lets you know how big a loan you’ll likely qualify for, which can help guide your home search and ensure you stay on budget. Additionally, a preapproval shows sellers you’re serious about a home purchase and may give you a leg up on other buyers.
When applying for preapproval, you’ll need to:
- Provide information regarding your income, debts, past residences, employment, and more. You will also need to agree to a credit check.
- Know what down payment you can offer. If you’re going to use gift money from a loved one, you’ll need a gift letter from the donor saying it doesn’t need to be paid back.
- Provide some documentation. Your lender will need recent pay stubs, bank statements, W-2s, tax returns and other financial paperwork in order to evaluate your application.
If you want your pre-approval application to go smoothly, go ahead and gather your financial documentation early, and have it ready to go once your lender requests it.
Step 4: Consider down payment assistance
If your student loans are making it hard to save up that down payment (and you don’t have gift money coming from a family member or other donor), you’re not completely out of luck. There are a number of assistance programs that can help you cover both your down payment and closing costs on your loan.
The assistance usually takes one of four forms:
- A down payment grant. These are interest-free and do not need to be repaid.
- Forgivable second mortgages. These are technically second mortgage loans on top of the one used to finance your house, but are forgiven if you live in the home for a certain number of years.
- Traditional second mortgage. These programs give you assistance via a low-interest loan and need to be paid off monthly, just as your primary mortgage does.
- Matched savings programs. These programs encourage you to save up funds in a dedicated down payment savings account. Then, the institution or agency offering the program matches those funds, usually up to a certain threshold.
To qualify for these programs, you might need to:
- Be a first-time homebuyer
- Have an income below a certain threshold
- Complete a homebuyer education course
- Be a military member, veteran or public servant (teacher, firefighter, EMT, etc.)
- Commit to a certain level of savings each month
Agencies may also consider your credit score, debt-to-income ratio and other financial factors when evaluating your application for assistance. The location you’re buying in and its median income could also play a role.
Step 5: Look into first-time homebuyer loans and programs
In addition to down payment assistance programs, you can also take advantage of one of the many first-time homebuyer mortgage programs that are offered by both the federal government and state-based agencies. These programs offer low interest rates, and many have no down payment requirement, which can be an especially big boost if you’re dealing with a heavy student loan burden.
Check out the table below for a list of federal first-time homebuyer programs and the specific requirements for each.
Individual states also have their own first-time homebuyer programs and assistance offerings. Many of these help with closing costs, down payments and more. There are also state-backed loan programs that can reduce your interest rate, lower your monthly payment and help you save significantly over the course of your loan if you qualify.
You’ll find a full list of state-specific resources at HUD.gov.
Step 6: Find a co-borrower
If you have a fellow grad or a friend or family member who also wants to get out of the rent race, teaming up to buy a house could benefit you both. In this scenario, they become your “co-borrower,” applying for the mortgage loan jointly with you.
The advantage here is that it allows both of your incomes and credit profiles to impact the application. That could mean qualifying for a higher loan balance, an easier approval process or a lower interest rate if they have a solid financial foundation. You can also pool your savings for a bigger down payment — another step that will lower your monthly housing costs and save you big on long-term interest.
Keep in mind though: If you apply with a co-borrower, their debts and credit score also count toward your application. So, it might not be helpful if their financial position isn’t strong.
If you don’t want to outright purchase a house with someone else, you could also ask a friend or relative to become a co-signer or guarantor on your loan. This would allow lenders to consider their income and credit on your loan application, but it wouldn’t actually give them ownership of the property.
Student loan debt can be a drag, especially if you’re trying to buy a house. Fortunately, there are options. By taking advantage of the right loan programs, working on your credit and DTI and teaming up with the right partners, you can improve your chances significantly, not to mention lower the cost of buying a home both up front and for the long haul.