How to Buy a Home When You Still Have Student Loans

This is a guest post by Andy Josuweit, CEO of Student Loan Hero. Andy has a fantastic site and it’s a great resource for any with a student loan. Do yourself a favor and check it out Pilgrim.

The time it takes for college graduates to pay off their student loans can extend 10, 20 – even 30 years. With such a long road ahead, it’s no wonder so many grads worry they’ll never be able to purchase a home.

Fortunately, the majority of student loan borrowers don’t need to worry at all. With the right financials, nearly any graduate with student debt can complete this major milestone – that is, without going broke.

Buying a Home with Student Debt: 4 Moves to Make First

Still, the odds of qualifying for a mortgage and becoming a homeowner improve immeasurably when you stop to take a few, much-needed steps. Here are four money moves you should make as soon as you begin pondering the prospect of homeownership:

Step #1: Find your debt-to-income ratio and improve it.

While any amount of student loan debt can feel like a burden, it’s your total debt that lenders care about.

When you apply for a mortgage, lenders look at how much of your income is dedicated to combined debts each month; that includes things like car payments, credit card bills, personal loans, and yes, student loans.

After examining your financials, lenders will establish your debt-to-income ratio (DTI), which is the percentage of your income that goes to debt repayment each month. Most lenders prefer a ratio of 36 percent or less – including the potential monthly payment on a mortgage.

If your DTI is out of whack, you may need to pay down other debts before you apply for a mortgage. Now could be the perfect time to tackle your auto loan’s lingering balance, pay off credit cards, or annihilate a personal loan.

Once your DTI is where you want it to be, you’ll be in the best position to get a mortgage.

Just remember, your new mortgage payment shouldn’t push your DTI over 36 percent. If you’re getting too close, you can consider paying off other debts, refinancing your student loans in order to lower your monthly payment, or searching for cheaper home.

Neal’s Notes – Also, make sure you buy a house you can really afford!

Step #2: Save up for a down payment.

While some government-backed loans (such as FHA and VA loans) let you purchase a home with little to no down payment, most financial advisors suggest saving a down payment of 20 percent or more. This not only increases your chance of qualifying for a home loan, but also lets you avoid paying private mortgage insurance (PMI).

PMI can add anywhere from 0.5% to 1.00% of the entire amount you borrow on an annual basis, but you’ll need to pay it monthly. This effectively beefs up your monthly mortgage payment and decreases the amount of money you can borrow.

Step #3: Improve your credit, one month at a time.

Mortgage lenders have pretty high standards when it comes to your credit. A sub-par credit score could prevent you from getting approved.

For FHA and VA loans, a minimum FICO score of 500 is set by federal law. However, a down payment of 10 percent or more is typically required of borrowers who fall on the lower end.

Most traditional lenders require a score of at least 620, although borrowers at that level may need to pay higher interest rates. To qualify for the lowest interest rates and best terms, you’ll need good credit, which is generally described as a credit score of 720 or higher.

Lenders typically rely on the FICO scoring method to determine eligibility for a home loan. If your FICO score is too low, you’ll need to take certain steps to improve it.

For example, pay off debt to decrease your debt-to-income ratio, settle any delinquent bills, and use credit responsibly to build your credit history over time.

Since 35 percent of your FICO score is based on your payment history, one of the best things you can do to raise your credit is pay all your monthly bills on time or even early.

Step #4: Create a monthly budget that includes the costs of homeownership.

Even if you’re in the midst of improving your credit score or saving up for a down payment, it’s a smart idea to build a budget based on the assumption you’ll eventually get your house. Owning a home results in a ton of costs beyond your monthly payment.

Figure out how much a monthly payment might be on the type of home you’re considering. Then tack on another 10 – 15 percent to account for home repairs and ongoing maintenance. Depending on the type of property you plan to buy, you may also need to account for utility payments, lawn care, or even pool maintenance.

How will these new expenses affect your bottom line? If you’re worried your new monthly payment will push you to live too close to the cuff – or worse, beyond your means – you’ll need to save up a larger down payment or consider a less expensive home.

Either way, you’ll be much better off if you consider the costs – and the consequences – of homeownership ahead of time. Once you buy, you’re stuck in whatever financial situation you designed.

The Bottom Line

If you’re a recent grad with student loans, rest assured your dream of homeownership is not off the table. With a few smart money moves and a whole lot of planning, you can achieve this life-changing milestone.