You got the degree and the job. Now you're readying for the next phase in life: buying your first home. But earning that college degree left you with student loans, and you're concerned that your existing debt will complicate the homebuying process.
There's good news. Buying a home with student loans is possible. Here's what you need to know if you want to buy a home but still have other types of debt.
The Homebuying Process
The first step in the homebuying process is figuring out if you can get preapproved for a mortgage. A preapproval lets you know how much you may be able to borrow and if you're likely to get approved for a home loan. Preapproval also estimates your monthly mortgage payment, so you can see if buying a home works with your current budget.
When you go through the preapproval process, the lender looks at your credit score, income, current debt and assets. The lender uses that information to decide if you're a good candidate for a loan. Once you get preapproved, you can start looking for homes in your price range. When you find one you like, you put in an offer. If the seller accepts your offer, you're well on your way to becoming a homeowner.
Types of Debt
Having debt isn't necessarily a bad thing. Certain debt types can help you get ahead in life and achieve your goals. While you may not love having to pay your student loans each month, they allowed you to earn a degree.
Student loans and mortgages are often called "good debt," as they typically pay off in the long run. Your earning potential increases with a college degree, and you benefit from the equity in the long run when you buy a home.
Your student loans also help you get on the credit history ladder. To get some types of credit, like a mortgage, you need to have an existing credit history. Making regular payments on your student debt demonstrates that you're a responsible borrower, making you more attractive to lenders.
While student loans typically fall into the good debt category, they can be considered "bad debt" if the monthly payment is more than you can afford or if you fall behind on payments. Other types of bad debt include credit cards with high interest rates or debts that bring your credit score down, often due to missed payments.
Student loans can also be a type of bad debt if the monthly payment makes up a significant part of your income. Lenders look at your debt-to-income ratio (DTI) when reviewing your mortgage application. Your DTI compares the amount of all your debt payments to your monthly income. If you bring in $5,000 a month and pay $2,000 toward debt, your DTI is 40%, which is on the high side.
Can You Buy a Home With Bad Credit?
Missed or late payments can lower your credit score significantly. So can having a high credit utilization ratio. Your credit utilization ratio compares the debt you have to the amount you can borrow. If you have a credit card with a $5,000 limit and $2,500 in credit card debt, your utilization ratio is 50%, which is high.
How long you've had credit also affects your score. If student loans are the first debts you've ever had, you may not have a lengthy credit history, which can mean your score is lower than it could be.
While lenders do give borrowers with the highest credit scores the best rates, having a lower score doesn't exclude you from getting a mortgage. To compensate for a lower score, a lender might:
- Require a higher down payment.
- Offer you a higher interest rate.
- Direct you to an FHA loan, which can be more helpful to borrowers with lower scores.
In some cases, you may want to wait and bring your credit score up before you start the homebuying process. Paying down some of your student loan debt and getting current on past-due accounts will help raise your score.
Should You Pay Off Debt Before Buying a Home?
You don't have to wipe out your student loans entirely before you apply for a mortgage. In some cases, you may want to focus on paying them down before you start thinking about buying a home.
Take a look at your debt-to-income ratio. If it's above 50%, try to pay off more of your student debt before seeking out a mortgage.
Another reason to pay off student loans before buying a home is if the interest rate on those loans is high. The longer you take to pay off loans with a high rate, the more you pay, which can affect your ability to reach other goals. You'll spend less over time if you accelerate debt payments, particularly for debt with high interest rates, and then focus on your other life goals, such as buying your dream home.
Checklist for Buying a Home With Student Loans
If you're ready to start the homebuying process with student loans, here's what you can do:
- Check your credit. Before you do anything, take a look at your credit report and score. Knowing your score gives you an idea of whether a lender is likely to approve you (there are other factors too). Checking your report also lets you verify the information is correct. If you see errors, contact the credit reporting bureau to correct them.
- Research mortgage options. Some mortgage types, such as FHA loans, can be particularly helpful for people with less-than-perfect credit. Knowing your home loan options gives you a better understanding of loans you may qualify for.
- Increase your income. You can improve your DTI in two ways. The first way is to pay down debt. The second way is by increasing your income. Options include finding a side hustle, asking for a raise or finding a higher-paying job. Note that changing jobs while getting a mortgage may disrupt the process, in some situations. Lenders typically want to see at least two years worth of employment in the same field, so moving up the career ladder in your current industry won't negatively impact your mortgage eligibility. However, changing industries or going from a W-2 position to a contractor position, or a position that relies on bonuses or commission, even if it means more money, might.
- Keep making student loan payments. Continue to make on-time payments on your student loans and any other debts. Doing so keeps your payment history positive and lowers your DTI.
- Apply for preapproval. If you're happy with your credit score and your DTI isn't too high, apply for a mortgage preapproval to see how much you can borrow and what your monthly payment will be.
- Shop for a home. With your preapproval in hand, you're ready to start shopping for your new home.
Your student loans don't have to stand in the way of homeownership. The most important thing when buying a home is being financially stable. If you have a steady income and can afford your monthly loan payments, you can feel confident when you apply for a home loan.