Purchasing a Home with Student Loan Debt
For the nearly 45 million Americans paying off student loan debt, a large purchase such as buying a home may seem far out of reach. Even if it seems like a good time to purchase, you might wonder if it’s even a good decision while you still have student loan payments. However, with the right preparation, buying a home with student loan debt is still very possible- let’s look at some things to consider.
Your Credit Report
Your chances of being approved for a home loan are significantly greater with a good credit score. The minimum score for a home loan is typically 620. When viewing your credit score, keep in mind that it can vary by credit bureau, although the majority of lenders will use your FICO® score in their evaluation. This is only the minimum score; with a higher credit score, you will be eligible for a better interest rate. For the best rates, you should aim for a score of 740 or higher.
A lot of factors go into your credit score, but one of the largest factors is your credit utilization ratio. This is the ratio of your total available credit versus your total credit usage. To avoid negatively affecting your credit rating, you should aim to keep this number under 30%. You should also strive to pay all of your bills on time and in full. The length of your credit history is also a factor in your credit score calculation; even if you have a low credit utilization ratio and pay all your bills on time, your credit score may be on the lower side if you’ve only opened lines of credit relatively recently.
Your credit score is only a numerical representation of the history in your entire credit report. If you are planning to buy a home, make sure to get a copy of your full credit report to look for any mistakes. It is not uncommon for things to be mistakenly reported to the credit bureaus or attributed to the wrong individual. If you find a mistake on yours, you can dispute it with the offending credit bureau to get it removed. There are many subscription services that offer access to your credit report, but the government also allows you to obtain a free copy once per year.
Another thing lenders will look at is your debt-to-income ratio, or DTI. This ratio shows the percentage of your monthly income that goes to repayment on any debt. This number should ideally be less than 36%. The actual ratio you need will depend on the lender though.
If your student loan payments are a significant factor in your DTI ratio, you can potentially consolidate the loans for a lower monthly payment. With federal student loans, you can apply for an income-based repayment plan. The same applies to any credit card debt; if you are unable to pay it all off, look into consolidating it into a personal loan with a lower interest rate. Obviously, if you are able to increase your income, this will also help the debt-to-income ratio.
For many prospective buyers, the biggest challenge is saving enough money to make the down payment on a home. In the past, the “magic number” for a down payment was traditionally 20%; however, FHA loans only require a payment of 3.5 percent, although you will also need private mortgage insurance (PMI). Certain states also offer down payment assistance to single parents or low-income residents. Veterans and active military members may also qualify for assistance with down payments.
You may also be fortunate enough to have a relative that can assist with your down payment. Keep in mind that lenders will require a letter to certify this money is a gift, not a loan, and that the individual gifting the money is a close relation.
The Costs of Homeownership
If you’ve checked off all the above boxes, you could be well on your way to becoming a first-time home buyer. However, you should also make sure you are fully prepared for all the other costs associated with homeownership. This includes property taxes, homeowners insurance, and any homeowners association fees.
As noted above, if you have a smaller down payment, you’ll likely have to pay for private mortgage insurance as well. You’ll also need to be prepared for any unexpected home maintenance and repair costs. To offset those out-of-pocket costs, make sure a Choice Home Warranty is included on the home.
Make sure to work with a knowledgeable real estate agent who can help you understand these costs and work out a budget that works for you. With a careful budget and some preparation, your student loan debt doesn’t need to keep you from homeownership any longer.