How to Get a Mortgage When You Have Student Loans
Banks have tightened up their lending rules in the years following the housing crash of 2008, making it more difficult than ever for some people to get mortgages.
Is it possible to get a mortgage when you have student loans? It is, but it requires some work and a little compromise.
Almost seven in 10 college graduates leave school with outstanding debt, according to figures from the Institute for College Access and Success. Among that group, the average debt is $28,950 per borrower — about two-thirds of the average yearly salary for a recent grad.
This means two things: 1) Recent college graduates have weakened home purchasing power, but 2) It’s not impossible to buy a home while you’re carrying student loans.
It all comes down to your debt-to-income ratio.
How mortgage approval works
When approving you for a mortgage amount, the bank uses a simple formula called the debt-to-income ratio to determine what to offer.
It calculates your ability to safely pay on your loan — remember, banks only make money when you pay on the loan, so it’s in their best interest to give you a mortgage that you can handle — while factoring in all of your current obligations. The formula looks something like this:
Monthly payments on debt / Monthly income = Debt to Income
Note that this doesn’t take your total debt into consideration, nor does it look at your annual income. Instead, it’s a snapshot of your month-to-month debt obligations and how much room you have to take on a mortgage.
For example, a recent graduate who makes $4,000 per month and is paying $300 per month in student loans would have a 7.5 percent debt-to-income ratio. That’s fantastic. Add in car payments, credit cards and other debt, and a more likely picture would be somewhere around $1,000 on the $4,000 in income.
That’s a 25 percent debt-to-income ratio, and most lenders will balk at extending credit beyond a 36 percent ratio. That means the person in our example would likely have about $440 per month to put toward their mortgage.
How to improve your debt to income ratio
Just because you have student loans doesn’t mean you can’t get a mortgage. With a little bit of work and compromise, you can get a mortgage you’ll be happy with.
- Pay off small debts. Once your monthly payment is gone, it’s off your debt-to-income ratio entirely. That means that instead of dedicating extra cash to paying on your largest debts, try to first pay off any smaller debts that are within reach. It will free up some room within your ratio.
- Additional income. Take on a second job or do freelancing work outside of your normal work, which will allow you to pay down your student debt faster.
- Reduce spending. By reducing nonessential spending — cutting down on eating out, passing on the cable subscription or taking public transportation — you’ll have more cash on hand for both your down payment and to pay down your debts.
- Consolidate existing debt. Shop around for a credit card with a low APR, and use it to pay off some of your higher interest debts. If needed, you can also consolidate your student loans.
- Plan ahead. Your greatest asset in improving your debt to income ratio is time. By starting early and planning toward your mortgage, you can take more long lasting steps toward reducing your debt.