Graduating from college and buying a home are two classic components of the American dream. But the unfortunate reality is, many Americans wonder whether their student loans will keep them from ever owning a house. At the end of 2020, Americans’ outstanding student loan debt reached an all-time high of $1.56 trillion.1 But while student loan debt means you have some important details to consider before attending an open house, it doesn’t necessarily mean you can’t buy a home. Below are a few tips to help you (or the recent graduate in your life) buy a home while managing student loan debt.
Tip #1: Focus On Your Credit Score
While you can’t magically change how much student debt you’re currently facing, you can focus instead on optimizing your credit score, which mortgage lenders rely on to decide whether to offer you a loan. It’s one of the pieces of information lenders collect as they assess your entire financial picture. The most common credit score scale ranges between 300 and 850. Generally, any credit score above 700 is considered good, and above 800 is excellent.2 Not only can a good credit score help you secure a loan, but it can also affect that loan’s interest rates. In some cases, the higher your credit score, the lower the interest rate. Unfortunately, large amounts of debt can have a significant impact on your score, so it is extra important to focus on paying off other loans, like your credit cards, in full every month.
Tip #2: Evaluate Your Debt-To-Income Ratio
Surprisingly enough, it’s not always the amount of debt you have that can affect whether or not you’ll receive a loan. Instead, it’s the ratio of how much debt you have to how much income you receive. Find out what percentage of your monthly income goes toward paying off debt (credit cards, car payments, student loans, etc.) to determine your debt-to-income ratio. As you might expect, the lower the percentage, the better your chance of receiving a mortgage loan. As simple as it sounds, there are only two ways to lower your debt-to-income ratio: reduce your monthly debt obligations or increase your monthly income.
Tip #3: Monitor Your Credit Utilization
Another important factor is your credit utilization—the percentage of your credit limit that you are borrowing at any given time. For example, if your credit limit is $4,000 and you have a balance of $2,000, you’ve utilized 50% of your available credit. If you’re looking to buy a home, you’ll want to work on keeping your credit utilization low; ideally, lenders like to see that you’re using 30% or less of your credit limit. You can reduce your credit utilization by paying off your credit cards multiple times per month. You might also consider setting up a credit utilization alert with your credit card issuer.
Tip #4: Consider Seeking Pre-Approval
If you’re perusing open houses before securing a mortgage, you could be putting the cart before the horse. Getting pre-approved by a lender before looking at homes can help you understand how much you will realistically be able to spend. Nobody wants to fall in love with their dream home only to find out they can’t secure the funds for it. Note, however, that banks will often pre-approve you for a significantly larger loan than you may be able to afford. As Britta likes to say, the amount the bank approves you for isn’t how much they think you can afford; it is how much they are willing to bet that you will find a way to pay. Speak with a financial planner to determine how much of your income you can realistically put toward a mortgage payment and base your budget on the lower of that or your pre-approval amount.
Tip #5: Explore Assistance Programs
When it comes to buying a home, you’re not alone. There are programs to help certain home buyers afford a down payment, even if they have student debt. Some of the most common programs include loans through the Federal Housing Authority (FHA), USDA loans for those looking to buy a home in rural areas, and Department of Veterans Affairs (VA) loans. Depending on your unique circumstances, you could be looking at low down payment options (or even no down payment at all). Some states, including Ohio, even offer down payment assistance programs to help you afford your first home3.
Just because you’re stuck paying back student loan debt doesn’t mean you can’t take on a mortgage. Instead of focusing on how much you owe, work instead to optimize your financial standing wherever you can. This can help lenders see you as a responsible, money-savvy borrower who is ready to handle the responsibilities of homeownership.
Wondering if you are financially ready to commit to owning a home? Contact us today.