It's different to be a first-time home buyer as compared to an experienced one.
First-time home buyers often skew younger than the general home-buying population which means less work experience, lower income levels, and usually, less money saved for down payment.
It also can mean higher levels of federal student loans and debt.
Concerns about student loan obligations are among the reasons why first-time home buyers account for a smaller percentage of the housing market as compared to recent years.
According to a study by American Student Assistance, 55% of student loan holders said their debt is causing them to put off homeownership.
And, despite the historically low levels of today’s mortgage rates plus a wide array of low- and no-down payment mortgages available to first-time buyers, student-loan-holding consumers are discouraged. Many would-be buyers aren't even applying -- worried that their debts will make homeownership impossible.
The truth, though, is that homeownership and student debt aren't mutually-exclusive. You can buy a home, get approved for a mortgage loan, and still make good on your student loans.
This post discusses student loans and debt; and, is the next in a series meant to help first-time home buyers buy their first home and get approved for their first mortgage.
Down Payment, Credit Scores, & DTI: The Pillars Of Your Approval
As a home buyer, your ability to get approved for a mortgage is based on three main factors -- your down payment on the home, your current credit score, and your household income relative to your household debt.
Other traits matter, too, such as your status as a U.S. citizen and your employment history, but these three matter most.
Down payment matters because the size of your down payment determines for which mortgage loans you might be eligible.
For example, the VA mortgage and UDSA home loan both allow for 100% financing. Therefore, if you plan to use either of these two programs, it doesn't matter whether you have a down payment or not.
However, with no down payment, you would not be eligible for an FHA mortgage or a conventional one, which require 3.5% down and three percent down, respectively.
Your credit score matters for the same reason.
All mortgage programs require that buyers meet some minimum credit score requirement. For some programs, minimum credit scores are high. For other programs, minimum credit scores are low.
Your credit score will determine for which programs you can be eligible.
It's your monthly income relative to your debt, however, that is arguably the most important trait in your mortgage loan approval. Known as your debt-to-income ratio (DTI), this calculation is believed to be the best predictor of whether you can actually afford to buy.
Much more than the size of your down payment or your credit score, your DTI will determine whether you can mortgage-approved.
How Do Student Loans Affect Mortgage Approvals?
Your debt-to-income ratio is a percentage which shows the amount of your monthly income required to repay your debts.
For example, if you earned $5,000 per month and had a monthly debt obligation of $2,000, your debt-to-income ratio would be 40%.
That's hard to tell. DTI is heavily influenced by where you live so residents of San Francisco, where rents are relatively high tend to exhibit higher ratios than residents of Kansas City, where rents are relatively low.
In general, your DTI must be 43% or less in order to get mortgage-approved.
You may find this figure to be too high for your tastes, and that's okay. There is no rule that says you have to use the entire forty-three percent of your household income on debts. It's merely the maximum level at which home buyers can get typically approved.
For first-time buyers with student loans, though, using every available piece of DTI may be necessary. This is because student loans can eat into your budget and redirect monies you'd rather be putting toward housing.
Consider that the average college student graduates with monthly debt totaling $300 per month. Add a car payment and a few credit cards, and monthly debt more than doubles to eight hundred dollars per month.
Assuming a monthly income of $5,000 and a maxing out of the allowable debt-to-income ratio, a first-time home buyer with student loans can "afford" a home for around $240,000, assuming a low-downpayment FHA mortgage.
However, this is for a loan at the maximum DTI of forty-three percent. That sort of payment may make you uncomfortable. You may prefer to be closer to 33% DTI, which is a range in which financial planners recommend you live.
At 33% DTI instead of the maximum forty-three percent, your maximum purchase price for a home falls to $130,000 -- and this is how student loans can affect your mortgage loan approval. The more student loans you carry, the less home you can afford.
But, student loans don't have to be a barrier to entry. You have means to reduce your monthly student loan payments, which can help you with your home loan approval.
Student Loan Advice For First-Time Home Buyers
Student loans affect your monthly budget which, in turn, affects your DTI. However, there are ways to reduce what you owe to the government each month to help you qualify for "more home".
One method by which to reduce your monthly student loan obligation is to switch to a graduated repayment plan on your loans.
A graduated repayment plan is one for which the payment starts low, then rises every two years to meet the rising income of a typical college graduate. With lower monthly payments, your debt-to-income ratio is reduced, which can help you qualify for your home loan.
Loan consolidation is another way to reduce your monthly student loan obligation.
It's likely that your student loans are of different amounts, and at different rates of interest. By consolidating your loans, your can lump your principal balances together at, hopefully, a lower interest rate.
You can also request a lengthening of your payback period, known as your "term".
By lengthening your term to 15 years or 20 years, you can reduce the amount that you owe each month, which lowers your DTI. This will increase the long-term interest costs of your student loans, but will lower your monthly obligation.
And, a third option doesn't relate to student loans at all -- but, rather, credit card payments and other monthly debts.
If graduated payments and student loan debt consolidation are not part of your plans, consider reducing your high-balance credit cards or any other debt which carries a high minimum monthly payment.
For example, if you have a credit card which requires a minimum monthly payment of $150, and that's more than your other credit cards, you can reduce that card's balance, which will reduce the monthly payment due, which helps to lower your DTI.
Mortgages For Buyers With Student Debt
As a first-time home buyer with student debt, there are a number of mortgage loan programs well-suited for your needs.
Many allow for low-downpayment and 100% financing, as well.
The FHA loan, for example, which is backed by the Federal Housing Administration (FHA), allows for a downpayment of just 3.5 percent for borrowers with a credit score of 580 or higher.
FHA loans allow debt-to-income ratios of up to 43%, but will allow higher debt-to-income ratios on a case-by-case basis .
You can also use the FHA home loan if your credit scores are below 580, but a larger downpayment of ten percent is required.
The Fannie Mae HomeReady™ mortgage is another loan available to borrowers with student loans. Via HomeReady™, buyers can show a debt-to-income of up to 50%, with certain off-setting factors; and a down payment of just three percent is allowed.
The minimum credit score to get approved for a HomeReady™ home loan is 620.
Buyers with military experience who have student loans should also consider the VA Loan Guaranty program available as part of the G.I. Bill.
VA loans allow for 100% financing and, according to loan guidelines, the maximum debt-to-income of 41% can be over-ridden if some of your income is tax-free income; or, if your residual income exceeds the acceptable loan limit by twenty percent of more.
There are lots of tools for people with student debt obligations to purchase a home. This article nicely summarizes some of them. Feel free to contact me to discuss your situation.