This article is from our friends at LendEDU. LendEDU helps graduates save money on their student loans through price transparency.
By Tom Flynn
One of the tragedies of the student loan crisis? Many borrowers are delaying or forgoing life milestones like buying a home or having children because of their student loans. Are you considering buying a home but still have student loans? Then you might be afraid of the impact your student loans will have on your ability to qualify for a mortgage.
You’re right to be worried. There are number of ways in which student debt can impact whether or not you’re approved for a mortgage and how much you’re approved for. Essentially, your student loans could mean the difference between being able to live your homeownership dream and having your hopes dashed.
The majority of lenders look at your debt-to-income ratio before approving you for a loan. That is the ratio between how much you pay each month towards your debt and how much you make. If your debt-to-income ratio is below 36% of your income with all your current debt payments and your potential mortgage payment, then lenders will likely approve your loan.
For example, if you and your spouse currently make $8000 a month and your student loan payments and your mortgage payment will come to around $2000 a month, then your debt to income ratio is just 25%. And you will likely be approved. But if your debt to income ratio is higher than that because of your student loans? Then you might need to take action to increase your chances of getting approved for a mortgage.
Reduce Your Debt
One of the best ways to improve your debt-to-income ratio is to reduce your debt. That means that you would have to expedite your repayment. There are a number of ways to do this that help in both small and big ways. For example, simply signing up for auto-pay will give you a small reduction in your interest rate – typically 0.25%. That will help you if you’re trying to aggressively pay down your debt. A higher proportion of your payments will be going towards the principal of your loan.
A more effective option though is to consolidate your student loans with a private lender. By refinancing your loans, you can often qualify for a lower interest rate. And that means you will save a significant amount of money on interest. This makes aggressively paying back your loans much easier. For more information, you should read this guide to learn how to consolidate student loans, the right way.
When you refinance, you can also extend the term length of your loan. That will reduce your monthly payments and could impact your debt-to-income ratio in a significant way – making you more likely to qualify for a mortgage.
Make sure that you take the time to calculate how long it will take you to repay your student loans. See how long it will take you to pay off you loans at your current rate. See how much faster you could pay them off if you paid a little more towards your loans each month. This will allow you to understand when you will likely be able to qualify for a mortgage. Most lenders do not include an installment loan in the calculation of your debt-to-income ratio if you only have 10 payments left on it.
Other Ways to Increase Your Chances of Approval
Another option is to reorganize your debt. If one spouse makes a much higher income and the other spouse carries the majority of the debt, then the high earning spouse could potentially apply for the mortgage and qualify on their own. To achieve this reorganization, you could focus your extra repayment dollars on paying off the loans of the spouse who makes the most money first. That way, you will be able to qualify for a mortgage sooner.
If you cannot reorganize or repay your debt quickly, then you might want to focus on making more money. Can you get a promotion, a pay increase, or a new job? You might be able to change your debt-to-income ratio enough to increase your chances of qualifying for a mortgage.
There are rules that affect freelance or other types of business income which require you to prove that you have been making that amount of money for two years before it’s usually included in your income calculation. But increasing your income by making more on the side could allow you to pay off your debt faster.
Another way to increase your chances of qualifying for a mortgage is to decrease the amount of money you would like to borrow. This is obviously not an ideal situation since it will mean that the home you buy might not be exactly what you want. In this case, you will have to consider whether being a homeowner is important enough to you that you don’t want to wait until you can borrow enough to get the home you want.
Tom Flynn is a New York City based personal finance expert. Tom enjoys drinking coffee, watching Bloomberg, and talking with millennials about their finances.