Buying your first house is one of life’s happiest events. Many Americans with student loan debt worry that their college loans will prevent them from becoming homeowners. Fortunately, that does not need to be the case. With student loan debt now approaching the second-largest consumer debt category, it’s essential to understand how it impacts your credit and mortgage application.
Credit is key
When you start the mortgage application process, the lender will consider, among other factors, your credit score and something called your debt-to-income ratio (DTI). Most of us are familiar with credit scores: a number from 300 to 850 that tells lenders if you’re responsible with the credit you’ve been offered and can afford additional obligations.
Student loans impact your credit score and appear on your credit report. The most crucial action you can take with your student loans is to pay them on time and in full. Lenders want to see you can manage debt responsibly. Paying your loans on time demonstrates that you’re a solid borrower who can be trusted. Late or missed payments will lower your credit score. As time goes on, your older loans will help keep your score high as payment history is important to lenders. Mortgage lenders also like to see that you can manage different types of available credit, such as your student loans, credit cards and car loans.
Calculate your debt
Relatedly, your DTI is the ratio of your monthly bills—car payments, student loans, etc.—to your pre-tax income. Most lenders use Federal Housing Administration rules to determine your maximum DTI. The FHA rule limits your total debt obligations to 43% of your income.
The larger your student loan payment each month, the higher your monthly debt obligations. This lowers the room left for a mortgage payment, and it can reduce how much home you can afford to purchase. If your DTI is higher than it should be, search for ways to raise your income or settle some debts early. Refinancing student loans may lower your monthly debt obligation and your DTI, improving your lending terms once you’ve completed the mortgage application process.
If you’re using an income-driven repayment plan from the federal government, educate yourself about how that impacts your DTI calculation. Federal guidelines don’t permit lenders to use the actual amount of your payment when calculating your DTI. Instead, lenders are advised to use one of four methods to calculate your federal student loan payment. The most common method is to use the standard repayment amount reported on your credit report. For example, if your average repayment amount is $1,000, but your income-based repayment amount is only $200, your lender will use the $1,000 to calculate your DTI.
Talk to an expert
Working on a mortgage application with student loan debt is achievable for millions of Americans. Pay your loans on time, keep credit card debt to a minimum and work with a lender who understands student loan debt. Check your credit report regularly and report any errors. By law, you have the right to obtain your credit report from each of the three primary agencies once a year. It’s quick, it’s free and it’s your right.
The loan officers at First Centennial Mortgage have a lot of experience working with borrowers who have student loan debt. They understand what it means help borrowers buy their first home, refinance their current home or buy their next home as their needs change. Contact the mortgage experts at First Centennial Mortgage today to get preapproved. Then, you can explore all the loan options at your fingertips knowing you are being expertly guided through the process.