It’s a common question asked over and over again: Will student loan debt keep me from owning a home? The reason is when you purchase an education you may have far more debt than what a new car costs and enough to feel like it’s a small mortgage.
The answer to whether student loans affects your chances of securing a loan for large purchase is divided into two parts: credit score and payment impact.
Especially for mortgages, your debt-to-income ratio is vitally important. This number represents all your monthly payments compared to your monthly pretax income. For instance, let’s says you make $4,000 per month before taxes. You have $300 in minimum payments on your credit cards and $600 in student loans. You have total of $900 of debt payments each month. $900/$4,000 equals 22.5 percent. To meet the Federal Housing Administration loans (FHA) standards for home ownership, you’d have to have a debt to income ratio including your mortgage payment “(principal and interest, escrow deposits for taxes, hazard insurance, mortgage insurance premium, homeowners’ dues, etc.)” of 43 percent or less. You’d have to stick to homes where your total mortgage payment would be $820 or less.
If you didn’t have a student loan payment, you could invest up to another $600 per month in a home. So does this mean your student loans could squash your home ownership dreams if you want a home with a total mortgage payment of $1000? In the immediate future, yes. In a few months, maybe not. Why?
If your student loans are federal, you might be able to change repayment plans to reduce the payment. For instance, you borrowed $50,000 in federal student loans at 6.8 percent, your payment could range from under $200 to just under $600. The highest amount is on a 10-year repayment plan while the lowest is based on income on the Pay as You Earn Plan. This is based an income that could result in a $4,000 per month take home for an individual. However, if you earn a lower income, your payment under Pay as You Earn could be well under $100.
Then there’s private student loans. You can ask your lender about extended repayment options to reduce your payment amount. Otherwise, pay the best course of action may be to repay your private student loan as fast as possible before your home purchase. Then, you’ll no longer have this payment. However, if it’s a large balance remaining, you may be better off paying off credit cards. With each credit card payment, you might reduce the minimum payment lenders use to calculate your debt-to-income ratio. Plus, high credit card balances impact your credit score much more than high student loan balances.