Can You Qualify With Student Loan Debt
If you’ve been out of college for a little while—or a long while—then you might be thinking about taking the leap into homeownership. But if you also still have student loans to repay, then you are probably wondering whether you should clear those first.
Should you repay your existing debts before you undertake new ones? Or is it okay to purchase a home despite lingering student loan debt?
As with most financial decisions, the answer is that it depends.
So that you can determine the best answer for your personal situation and goals, let’s take a look at some of the arguments for waiting and some for going ahead with buying a house while you still have student loan debt.
Reasons to Pay Off Your Student Loans First
1. Your debt-to-income ratio is too high.
When lenders decide whether you qualify for a mortgage, they review how much of your monthly income is devoted to debt repayment toward, for example, student loans, auto loans, and credit card debt. The overall result is your debt-to-income ratio (DTI), which further breaks down into the front-end and back-end ratios.
Front-End Ratio: The percentage of your income consumed by mortgage expenses
Back-End Ratio: The percentage of your income consumed by all debt burdens
To approve a mortgage, most lenders want potential homeowners to maintain a front-end ratio no greater than 28% and a back-end ratio no greater than 36%.
Some lenders allow back-end ratios as high as 43%, but that doesn’t mean that you should feel comfortable taking on a mortgage that pushes your DTI to the maximum rate. (See “house poor” below.)
If your back-end DTI is at least roughly 30%, then it’s probably best to put off a home purchase until you’ve paid off more of your debt and/or achieved a higher salary. Remember, just because you can qualify for a loan, that doesn't mean that you should take one out.
Note that one way to lower your DTI is by decreasing your student loan payments, either by refinancing your debt with a lower monthly payment—which improves the ratio between your monthly obligations and income—or by enrolling in income-based repayment for federal loans.
However, keep in mind that some mortgage types use a percentage of your total student loan balance (1-2%) to calculate DTI rather than using your actual monthly payment.
Alternatively, getting a raise or increasing your income through side work will also improve your DTI.
2. You don’t have enough for a down payment.
Many financial advisors recommend saving a down payment of at least 20% of the home’s purchase price.
Down payments of 20% are actually more common today than prior to the housing crash in 2008, since lending standards have tightened. While a few other options allow you to put down less than 20%—notably FHA loans, which allow as little as 3.5%, and VA loans given to qualified military veterans that home purchase with a 0% down payment—the 20% standard remains strong.
If your down payment is less than 20%, then you’ll likely require private mortgage insurance (PMI), which can add 0.5%–1% to your regularly monthly mortgage payment. If you purchase a home for $100,000, for example, then you could face an extra $41.66–$83.33 each month in PMI.
Is it a bad idea to buy a home if you don't have 20% down? The answer depends on a host of factors, including:
The price differential between the total cost of homeownership, including repairs and maintenance, versus the cost of renting. If owning a home is a substantially better deal in your part of the nation, even after adjusting for additional PMI payments, then there's good reason to buy a home with a down payment of less than 20%. This calculator will help you to factor in variables such as interest rates, inflation rates, opportunity costs, the rate of both rent and home price increases, maintenance costs, and HOA dues, among others.
The rising rate of home appreciation. In 2010, when home prices began skyrocketing, buying a home and paying less than 20% down was an attractive option, for market equity gains could promise homeowners a 20% position in only a few years, which would no longer require PMI. In 2015, by contrast, home prices across the nation have generally stabilized, though real estate is always local, meaning that specific pockets of the country exhibit different trends.
Your personal financial situation, including the size of your emergency fund, stability of your income, amount of other debt, and alternative uses of your down payment—are you likely to invest or spend it?
3. You don’t want to be house poor.
Homeownership requires more than simply paying a mortgage each month. It carries additional recurring, as well as unexpected, expenses that renters don’t face.
From regular maintenance costs to the expense of repairs for sudden problems: the roof starts leaking, the furnace breaks, the A/C needs to be replaced, the gutters need cleaning, the deck needs to be refinished, and the hardwood needs another coat of polyurethane.
Feeling exhausted yet? Your bank account will be.
Make sure that you have enough room in your budget to absorb these additional costs, not solely the cost of mortgage payments.
The best way to meet this demand is by purchasing a house that costs less than the price at which you're qualified to buy. For instance, if you keep your back-end DTI to 25% or 30% instead of the lender-recommended 36%, then you can put those savings in a repairs and maintenance fund.
4. You’re not sure where you want to be in 5–10 years.
Renting gives you the flexibility to change careers and move to new cities on a whim. Homeownership drastically limits that kind of freedom.
Sure, you can always sell your house, but that poses plenty of risks, hassles, and transaction fees. You could also rent out your house, but you may not want the experience of being a landlord.
If your job is unstable, if you’re contemplating a major career or lifestyle change, or if you’re just plain not sure where you see yourself in the next few years, then it’s best to wait before committing to owning a home.
5. There’s nothing wrong with renting for a while.
We know that everyone tells you that you’re pouring money down the drain when you rent, but there’s also no need to rush into homeownership.
If your finances are out of shape or you’re not sure of your long-term plans, then it’s okay—even advisable—to wait until you have more security and clarity before committing to something as large as buying a home.
Reasons to Buy a Home When You Still Have Student Loans
First, you have to want to buy a home, and the factors in your personal life—your family, your relationships, and you commitment to a specific location—point toward homeownership. In this sense, the only doubt in your mind should be financial, not emotional.
From this starting point, there is an array of factors that you should consider. The more of these criteria that you meet, the better. However, if you don't meet one or two of the criteria, then that isn’t an instant deal-breaker. Think of the following as a guide, not a mandate.
6. Your DTI looks good.
If your front-end DTI is significantly less than 28%, then that’s a good sign that you might be ready to take on the commitment of a mortgage while still being able to pay back your student loans responsibly.
7. You’ve saved up a sizeable down payment.
If you’ve been able to pay down your loans and also save enough for a 20% or higher down payment, then that’s another sign that you could be ready to take out a mortgage.
8. You’re making enough money to handle the costs accompany homeownership.
See “house poor” above.
9. You could get more for your money.
Aside from the prospect of building equity—which is certainly a factor to consider—you could also quite literally get more for your money by buying instead of renting.
Depending on the market in your area, you might be able to enjoy a home with more square footage, both indoors and out, as well as better fixtures and nicer amenities for the same monthly payment as a smaller or less-updated rental property.
If you’re thinking of starting a family soon, then this extra space could become necessary. Or, if you’re currently by yourself and you simply want more room, then you could always take on a roommate to help with the mortgage payment, thereby allowing you to channel that extra money into paying back your student loans and meeting other financial goals.
10. You have a low-interest student loan.
Student loans are typically the least pernicious types of debt compared to credit card debt and auto loans.
Student loan interest rates tend to be lower and allow an extended repayment period. They’re also unsecured, which means that you don’t risk losing any personal collateral should you need to stop paying them for a certain time. Though you would want to repay $10,000 in credit card debt ASAP, $10,000 in student loan debt is typically not so bad to pay off at the minimum payment rate.
Having student loans doesn’t necessarily put the kibosh on buying a home.
As shown, there’s no clear-cut right or wrong answer. There are strong arguments for buying a home right now, as well as equally solid arguments in favor of waiting. Make your decision based on your personal finances, priorities, and goals.
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