Have you graduated from college and started your first “real” job? Have you been in the workforce for some time?
Whether you’re fresh out of school or have been out for a while, there is an important question you need to address when applying for a home loan: How much student loan debt do you have? If you have some, you’re not alone.
Nearly 70% of recent graduates have student loan debt, with an average balance of $28,400, according to a report by the Institute for College Access and Success. The student loan debt load has grown more than 150% since 2005, according to TransUnion.
What does all that debt mean when buying a home?
Just like any other debt, your student loan will be considered in your debt-to-income (DTI) ratio. The DTI ratio considers your gross monthly income compared to your monthly debts.
Ideally, you want your outgoing payments, including the estimate of new home cost, to be at or below 41 percent of your monthly income. There are some exceptions that allow you to exceed this, but you should aim for this benchmark.
Let’s say you make $3,000 a month and have the following debts:
- Estimated house payment with taxes and insurance is $700
- Student loans are $250
- Credit card is $50
- Car payment is $150
Your DTI ratio would be the sum of those debts ($1,150) divided by $3,000 — 38 percent.
If your car payment and credit card were $300 more expensive, your DTI ratio would climb to 48 percent, which is not ideal. That doesn’t mean you absolutely can’t qualify, but a loan officer will have to look at some compensating factors on a case-by-case basis to approve you. Some of the more common compensating factors include a high credit score, good credit history or additional income in your household.
Deferment v. Forbearance
If you have student loans but aren’t currently paying them, your loans will fall into one of three categories: default, deferment or forbearance. According to the Bipartisan Policy Center 44 percent of the under-30 crowd is in forbearance or deferment and 17 percent are delinquent. That means only 39 percent of this group is currently paying their student loans.
If you are in default — meaning your loan payments are due each month but you aren’t paying the bill — then you will not likely qualify for a VA home loan. If your loans are in deferment or forbearance, the lender isn’t requiring you to make monthly payments at this time.
Is one better than the other? Simply put, yes. It’s better for your mortgage application if your student loan is deferred.
Deferment occurs under circumstances approved by the lender, most commonly enrollment in school. With deferment, your student loan principal and interest payments are put on hold. Your lender will not likely include your student loan payments in your DTI ratio if you can show that they’ll be deferred for at least 12 months after your closing date.
Forbearance Can be a Problem
Forbearance occurs when you can’t make your monthly student loan payment. The lender will agree to reduce your loan payment or cancel it completely for a specific period of time. Interest still accrues on your loan during a forbearance. Because forbearance is based on financial hardship it’s looked at with more scrutiny by a mortgage lender.
If you can’t pay your student loan, a mortgage lender will be concerned. You also won’t be able to make timely mortgage payments, which in most cases will be higher than a student loan payment. To deal with this increased risk a VA mortgage lender is going to require that the full monthly payments on a student loan in forbearance be included in your DTI ratio.
Student Loan Forgiveness
As the student debt crisis continues to be dealt with and new solutions emerge from the government, more opportunities to lighten your student loan debt are becoming available. There are a number of ways for your debt to be forgiven, for a full breakdown of the Department of Education’s Forgiveness, Cancellation, and Discharge Program, read their guide here. Military members and servicemen are eligible for forgiveness through military service or the Segal AmeriCorps Education Award.
If you’re considering a home purchase, first ask yourself if you’re on strong financial footing and ready to make the commitment. If you decide you’re ready call a VA loan specialist at 855-524-7279 to discuss how your student loans will play in the homebuying process. You can also email me with your questions at email@example.com.
Photo courtesy Will Folsom