Buying a house is an exciting milestone; for some, it’s the pinnacle of the American Dream. But if you’re working to pay off a mountain of student loan debt, applying for a mortgage may seem impossible. This article will explain how to get a mortgage when you have student debt
In fact, 41% of college-educated Americans have postponed buying a house due to their student debt, according to Realtor.com.
The good news is that there are options for those who feel overburdened by student loans. In the spring of 2017, Fannie Mae, a government-sponsored enterprise that securitizes mortgages, introduced some new policies to help student loan borrowers to buy a house.
There are also other things you can do to decrease your student debt burden to make buying a house possible.
Fannie Mae’s new rules
Here’s a breakdown of Fannie Mae’s new policies that can help certain student loan borrowers to buy a house or use their home equity to pay off student loans.
Prior to this, lenders had to use 1% of the outstanding loan balance as an imputed payment”
Income-driven repayment plans
Income-driven repayment plans make it easier for people with high student loan debt or low income to afford their monthly payments. But mortgage lenders weren’t allowed to use that low payment amount when calculating your debt-to-income ratio.
“Prior to this, lenders had to use 1% of the outstanding loan balance as an imputed payment,” says Casey Fleming, mortgage advisor and author of the “The Loan Guide: How to Get the Best Possible Mortgage.” The main reason is that, if you’re on an income-driven repayment plan, your monthly payments may go up or down each year depending on how your income and family situations change.
The problem, Fleming adds, is that “it’s common for student loan payments to be much less than 1%, so lenders were imputing a minimum payment in the DTI calculation that was much higher than the actual minimum payment.”
With the new policy, lenders can use the minimum payment as reported on the applicant’s credit report, which makes for a more accurate debt-to-income ratio.
More and more employers are beginning to offer student loan repayment as an employee benefit. But when it came to applying for a mortgage, your monthly payments still counted against you if your employer, parents, or anyone else was paying down your loans on your behalf.
“Now, if the student can document that their parents or employer have been making the payment instead, then the lender may exclude that payment in the debt-to-income calculation,” says Fleming.
You generally need to prove third-party payments for at least the last 12 months to qualify to leave your payments out of the calculation.
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Pay off student loans with home equity
College graduates with student loans have always had the option to use home equity to pay off their student loans through a refinance. But before the new rule, this transaction was considered a cash-out loan and came with extra fees and possibly even higher interest rates.
With the new policy, however, borrowers will receive the same rate on the amount they use to pay off student loans as they would with the refinanced mortgage loan.
“Depending on circumstances, this can save the borrower anywhere from 0.3750% to 2.625% of the loan amount in upfront add-on fees,” says Fleming.
Other things to do to improve your chances
If the new Fannie Mae policies don’t affect you or you want to want to cover all your bases, here are some other things you can do to make it easier to get a mortgage with student loan debt.
Make sure your credit is in order
The better your credit report and credit score are, the better terms you’ll get on a mortgage loan. Even if you manage to improve your credit enough to get a small fraction of a percentage lower on your interest rate, it could save you thousands over a 30-year loan term.
Get a copy of your credit report through AnnualCreditReport.com, and get free access to your credit score through sites like Credit Karma or Discover Credit Scorecard. If you see that there is room for improvement, work to build your credit for at least a few months before applying for a mortgage.
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Lower your debt-to-income ratio
How much debt you have is a big factor in determining whether or not you can qualify for a mortgage. Most lenders follow the 28/36 rule, which means that you should spend no more than 28% of your gross income on your monthly housing costs and no more than 36% on all of your debt combined (including the new mortgage payment).
It’s still possible to get a mortgage if you don’t follow this rule, but it could come with a higher interest rate, and you would be at a high risk of defaulting.
To lower your debt-to-income ratio, work to pay off smaller debts to get rid of their monthly payments. Even a small decrease in your monthly payments can make a big difference.
Work with a skilled loan officer
“The most important thing is to meet with a competent, ethical loan officer before you go mortgage shopping,” says Fleming. “Someone who understands underwriting and loan pricing can help the student optimize their chances of approval and optimize their circumstances for pricing, too.”
A good loan officer or mortgage advisor will have your best interests in mind and tell you what actions to take based on what’s best for you. For some, it may be to pay off debt, while for others it may be more important to horde more cash or simply rearrange their debt.
Take your time to research loan officers and mortgage advisors before choosing one. And don’t be afraid to “fire” them if you feel like they’re not meeting your needs or don’t have your best interests in mind.
Take your time to consider all your options
Buying a house is an exciting experience, and it can be easy to let your emotions guide you. Instead of rushing into it, however, take the time to consider every option that is available to you. When you’re mortgage shopping, be sure to compare several mortgage lenders to get the best rates and terms.
Take a look at your student loans, too. If there’s an option to refinance them to get a lower monthly payment, check out lenders that offer refinancing. Also, consider other ways to lower your student debt burden to make it easier to get approved, such as getting a side job.
A mortgage is a long-term commitment, so the more time you take now to make sure everything is in order, the more money you’ll save in the long run.