You went to college and left with not only a degree, but a whole slew of student loans. Now you want to buy your own home, but wonder how you will do it. Will lenders turn you away because of your college debt?
Luckily, lenders won’t push you away just because you have debts from college. They look at the big picture, just as they would with any other loan. Of course, if you are in over your head in debt, you might not get the loan you want. If, however, your debts are manageable and fit well within your income, you might be in good shape.
Let’s look at how this works.
The Debt Ratios
Your debt ratios are really what matter. The lender needs to determine how well you can afford a mortgage. They will look at two debt ratios:
- Front-end – Your housing payment versus your income
- Back-end – Your total debts plus your housing payment versus your income
If you have student debt, they could hurt your back-end ratio.
What’s the Front-End Ratio?
The front-end ratio is the total housing payment versus your gross monthly income. First, let’s talk about the income. They look at your income before taxes. For example, if you make $70,000 per year, you make $5,833 per month.
They then compare this amount to your proposed mortgage payment. This includes the principal, interest, real estate taxes, and homeowner’s insurance. If you take out an FHA, USDA loan or conventional loan with less than 20% down, you’ll also figure in mortgage insurance.
Each loan program has a maximum front-end ratio they allow. In general, they are:
- Conventional – 28%
- FHA – 31%
- USDA – 29%
What’s the Back-End Ratio?
The back-end ratio is where the student loans come into play. This is the total of all of the bills you pay each month. It only includes those that report on your credit report though. Think of things like:
- Credit card (minimum payment)
- Car loans
- Student loans
The lender will add up each of these payments as they report on your credit report along with the mortgage payment. They will then compare it to your gross monthly income. The individual program requirements are as follows:
- Conventional – 36%
- FHA – 41%
- USDA – 41%
- VA – 43%
A Real-Life Example
Let’s look at an example of what would happen to a person with student loans.
Let’s say you have $300 per month in student loan debt. You also have a car payment of $200 and a credit card with a $50 required payment. Your gross monthly income is $5,000 and your proposed mortgage payment is $1,200 per month.
Your front-end ratio would be:
$1,200/$5,000 = 24%
Your back-end ratio would be:
$300 + $200 + $50 + $1,200 = $1,750
$1,750/$5000 = 35%
How Else do Student Loans Affect Your Chances?
Now what happens if your student loans are deferred? Unfortunately, lenders can’t just ignore them, keeping them out of your debt ratio. They must include some type of payment. If your credit report shows a payment, the lender will use that for qualifying purposes. If there isn’t a payment reporting, you’ll need to provide documentation showing the amount of the future payment.
If a lender cannot secure supporting documentation, they will use 1% of the outstanding loan amount as your payment. For example, if you have $30,000 in student loans, they would use $300 as your monthly payment. As you can see, it works to your benefit to get some type of official documentation showing the future payment, especially if you will be on a special payment plan.
The good news is that student loans do not prevent you from getting a mortgage. They may provide a small obstacle based on the amount of the payment compared to your income. However, that is just a stumbling block and is for your own good. You wouldn’t want to take on a mortgage that you could not afford in the end. That would just lead to foreclosure and damaged credit.
Take your time when buying a home after graduating college with debt. Only take on what you can afford. It can take a long time to pay off student loans. If you add mortgage debt on top of it, you could be in serious debt for a long time. Getting your student debt under control first is the right first step to financial freedom.Click to See the Latest Mortgage Rates»