According to studies, on average college graduates in 2017 walked away with more than $38,000 in student loan debt. Add on graduate, medical, or law school and it’s even more. After you land your first job, the next step may be to buy your first home. How do you start paying down your student loans, qualify for a mortgage, and start saving for a house downpayment all at the same time?
If you have Federal student loans, you may have elected an income-based repayment plan (IBR), which makes it challenging for mortgage lenders to assign a payment amount when calculating your debt to income ratio. This is because your monthly student loan payment could change each year depending on your income, or your loan could be deferred or in forbearance. Your debt-to-income ratio is an important factor in qualifying for a mortgage and is a way for lenders to estimate your ability to make your monthly mortgage payments. The lower the better. When it comes to payments made under an IBR, conventional and federally insured FHA loans have different guidelines for determining the borrower’s monthly payment obligation to be used in their debt to income calculation.
For a conventional loan, the borrower must use one of the following:
- The student loan payment amount listed on the credit report.
- 1% of the outstanding student loan balance.
- The actual standard plan repayment amount reported on the credit report. Your credit report will always show your standard 10-year amount for “Amount Due”, not the amount you actually pay.
- A calculated payment that will fully amortize the loan over the repayment period (this means that you have to calculate a payment with no forgiveness after 20/25 years).
For an FHA loan, the borrower must use the greater of:
- 1% of the outstanding balance on the loan.
- The monthly payment reported on the borrower’s credit report.
- The actual documented payment, provided the payment will fully amortize the loan over its term.
The ability to save for a downpayment is another factor in determining if a borrower qualifies for a conventional loan or a FHA loan. Conventional loans typically require a minimum downpayment of 5% (10% for condominiums) while FHA loans can go as low as 3.5%. With both FHA and conventional loans, there are premium costs and monthly private mortgage insurance payments to consider. However, for individuals with large student loan balances, it raises the question: should borrowers focus more on paying down student loans or saving for a downpayment? In some cases (and against conventional wisdom) it may make sense to prioritize paying down student loans to take pressure off your debt to income ratio in lieu of targeting a higher downpayment.
If you are considering purchasing your first home but didn’t think it was achievable due to student loans, contact Sharkey, Howes & Javer to meet with a CERTIFIED FINANCIAL PLANNER™ to review your options and how to qualify for a mortgage that best fits your needs.