Student Debt and Mortgage Down Payments
Student Debt and Mortgage Down Payments
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Prepping for a Mortgage Down Payment with Student Loan Debt
Homeownership is a foundational aspect of the American dream, but today, many college graduates find themselves struggling to graduate on to owning a home. All too often, millennials and young workers are pushing off this milestone. In fact, a recent study by the National Association of Realtors and American Student Assistance highlights this fact by stating that young adults delay buying a house by seven years.
So, why is buying a home so difficult? Aside from prohibitive entry costs, student loans often get in the way and delay the process further. More than 45 million adults owe a collective $1.5 trillion according to recent student loan debt statistics. With the average borrower paying $351 a month to student debt, many potential young workers feel financially trapped without the ability to set aside funds for buying a home.
Simply put, high student loan payments create serious hurdles to getting approved for a mortgage. They impact your credit profile and gobble up your monthly income. It’s not the end of the world though, there are ways to deal with monthly expenses that can put you on the right track. First, it’s important to understand how exactly student debt impacts the mortgage process.
How Do Student Loans Impact Your Ability to Buy a House?
One of the pressing issues regarding student loan debt and home buying revolves around lender requirements for mortgage loan approvals. Since the housing market disruption in 2008 and 2009, mortgage providers tightened borrowing requirements. In general, it is more challenging to qualify for a home loan. With this in mind, there are several important criteria to consider.
First, debt-to-income ratio (DTI) comes to mind. DTI is the ratio of total monthly obligations (debt payments, utilities, rent, etc.) divided by total monthly income. Having a high DTI is considered a negative signal to creditors because more of your income is devoted to payments; basically, it means you don’t have to much extra cash. As mentioned, some student loan borrowers have high monthly payments. This may bring a debt-to-income ratio to a level that causes lenders to decline a mortgage application.
Furthermore, debt-ridden, first-time home buyers may find it harder to save up cash for a down payment. Mortgage lenders often require a down payment ranging from 3% to 20% of the home value. It’s generally beneficial to make a larger down payment on a mortgage because it can lead to better mortgage terms. However, this may not be viable when paying hundreds towards student loans each month. In addition, closing costs and relocation expenses simply add to the total cost.
Manage Student Debt Before Applying
Many graduated student loan borrowers are in a tough spot. No wonder many of them delay buying property for seven years. Despite the trouble, there are ways to reduce your monthly payments and save more cash each month. Doing so could mean the difference between being buyer-ready within a year or two or hopelessly far away from a new mortgage.
Income-Driven Repayment
An income-driven repayment (IDR) plan can reduce monthly payments. Offered by the Federal government, an IDR plan caps monthly payments at a percentage (10%-20%) of discretionary income which may be drastically lower than the standard plan minimum payment. Borrowers can put away more cash each month for a larger down payment, and it also reduces debt-to-income ratio – all while staying current on their student loans.
Just remember that IDR plans aren’t available for private loans – only for federal student loans. Furthermore, they often drive the cost of a loan over the repayment lifetime. IDR repayment schedules range from 20 to 25 years, so you could be paying for twice as long as the standard term. Keep these drawbacks in mind before applying for an IDR plan.
Student Loan Refinancing
Another option is refinancing student loans with a private lender. Student loan refinancing means applying for a new private loan to pay off outstanding federal and/or private student loans. The new loan may have a lower interest rate which would decrease monthly payments. Borrowers can also opt to extend their repayment term which also reduced monthly payments. In short, there are two ways to free up cash each month: with either a lower interest rate or an extended repayment term. Like before, lower monthly payments can open up room to save for a down payment.
Of course, there are obstacles to consider. Refinancing is well-known for a difficult application. If a borrower has low income and poor credit, then they are much less likely to get a lower interest rate or even qualify. Additionally, transitioning federal debt to a refinanced loan with a bank will negate any federal loan benefits. Also, extending the repayment term will increase the cost of the loan over time.
Federal Student Loan Consolidation
Similar to refinancing, borrowers can apply for a federal consolidation loan through the government. Consolidating allows borrowers to extend their repayment term up to 30 years which will reduce payments as a result. Reduced monthly payments can lower a borrower’s debt-to-income ratio, and it can help save more money each month. Both of these can help someone prepare for a larger mortgage down payment.
As always, remember the drawbacks. Federal loan consolidation does not offer a lower interest rate, so borrowers cannot save by virtue of lower interest. As mentioned earlier, extending repayment terms will also drive total loan costs.
AutoPay Discount
Finally, some student loan servicers and private lenders offer interest rate discounts for establishing automatic payments. This reduction ranges from 0.25% to 0.50%. While this may not drastically reduce payments, it could have a sizeable impact on high-balance loans, and the discount will reduce the total cost of repayment over time. Any reduction in cost can help potential homeowners save more money before applying for a mortgage. However, if you are signed up for autopay, stay vigilant with your bank account. You must have the funds in your bank account ready for withdrawal or risk a late payment.
Conclusion
Student loan debt is a reality for millions of college graduates, but it does not have to be a detriment to the goal of buying a home. Purchasing a home is possible when borrowers manage their student loans effectively. Loan consolidation, refinancing, interest rate discounts, and income-driven repayment programs may all lend a necessary hand in making student loans more affordable. In the process, borrowers may be able to improve their application outlook as well as save more money for the important down payment.
