Homebuyer Tips: Buying When you Have Student Loans
In case you haven’t heard, there is a student loan debt crisis in America. Currently, the amount of student debt owed – $1.5 trillion – is second only to mortgage debt. Even so, many Americans with student loan debt also hope to become homeowners at some point. Depending on how much you owe, student loans may make buying a home more difficult, but far beyond impossible. The 6 tips below may help you get there!
Keep Current on Loans
It’s important to make student loan payments on time every month so that you will show a positive payment history on your credit report. On-time payments make up a whopping 35% of your credit score: even one late payment can send it crashing down. This is especially important in the two years leading up to your home-buying adventure, but since negative information will stay on your credit report for up to seven years.
If you have a late payment from a student loan on your credit report, there is nothing you can do but wait it out and make sure that all debt payments going forward are on time. This includes credit cards, loans, student loans, and anything else that may show up on your credit report.
Stay Out of Default
Falling behind on student loans can be hard on your credit, but defaulting on student loans damages more than your credit score. It creates enormous hurdles to getting approved for a mortgage. The consequences of default on Federal Student Loans range from Administrative Wage Garnishments and Tax Refund Offsets to loss of professional licenses. Furthermore, when you default on Federal or Private student loans, fees and interest accrue so you end up owing much more in the long run.
If you have fallen into default with your student loans, it is important to know your options. With Federal Student Loans, there is hope to get those loans back on track through Rehabilitation or Loan Consolidation. Private Student Loans will go to collectors once defaulted and there is no option to get them back on track. You will have to pay them off either through
- arranging an affordable payment plan,
- offering a settlement,
- or saving up and paying them in full.
After all that, with both types of loans you will have to focus on re-building credit to get approved for a mortgage.
Avoid Forbearance and Deferment
There are times in life when your student loan payments may be unaffordable and you need to request a forbearance or deferment on your payments. Forbearances and deferments temporarily stop your payment and can help you avoid a late payment (and fees) if you are unable to make your payment.
As a temporary solution this is fine, but the downside is that when you enter a period of forbearance or deferment the interest on your loans continues to accrue. When that period is over, the interest will capitalize into the loan. In other words, it is wrapped into the balance and you owe the capitalized interest as well, and you will be paying interest on that new, higher balance.
If you are struggling to make your payments, it may be better to pursue one of the Income-Driven Repayment Plans available to Federal Student Loan borrowers. These plans may lower your payment and you will be working towards some type of loan forgiveness while in them. However, mortgage lenders have different ways of factoring these payments into your debt-to-income ratio (DTI) when looking at your loan application (see below), which is an important thing to consider.
Pay Down Private Student Loan Balances
There are few to no alternative repayment plans with private student loans. The best strategy for these loans is to get them paid off as quickly as possible. This will benefit you in many ways, to name a few:
1. With a quicker pay-off you will pay less interest, especially with high interest private loans.
2. It will help boost your credit score with on-time payments and lower debt amounts. Combined these make up 65% of your score!
3. The fewer loan payments you have the better for your debt-to-income ratio (i.e. the more mortgage you can approved for).
Understand how Different Loan Programs Consider Student Loans
Regardless of what payment plan you are in, your mortgage lender will look at your loan payments differently depending on which type of mortgage you get. It’s good understand the differences.
Fannie Mae Student Loan Solutions: This program was created with three benefits for borrowers:
- the student loan payment on the credit report will be used to determine debt-to-income ratio,
- debts paid by a third party will be excluded from DTI calculations, and
- it allows for a cash-out refinance for homeowners to pay off student loans.
FHA Guidelines: FHA’s guidelines maintain that regardless of the payment status of the loan the payment must calculated by using the greater of:
- 1% of the outstanding balance, or the payment listed on the Borrower’s credit report;
- the documented payment as long as it will fully amortize the loan over its term (in other words, pay it off over the term of the loan).
Freddie Mac Guidelines: The new guidelines make it easier for student loan borrowers to qualify for mortgages by lowering the amount used to determine the payment for DTI purposes: if the payment reported on the credit report is more than $0.00 the monthly payment reported on the credit report will be used; if the payment reported is $0.00 .5% of the outstanding balance as reported on the credit report will be used
These guidelines are up-to-date as of June 2019, but are subject to change.
6. Talk with an LSS Financial Counselor for Pre-purchase Counseling
If you are getting ready to buy a home and are not sure where you need to start, make an appointment with one of our experienced LSS Financial Counselors. We can help you estimate how much home you can afford, work with you to make a plan to improve credit, and save for a down payment. Schedule your free one-on-one appointment by calling 888.577.2227 today!
Author Shannon Doyle is a certified LSS Financial Counselor.