If you have a lot of student debt and you are trying to buy a home of your own, you may quickly realize that your student debt is an obstacle. Why do a lot of student loan debt and buying a home not play well together?
Student debt and back end Debt -to-Income Ratio (DTI): When applying for a mortgage loan, lenders will calculate your DTI. Basically they are comparing your income to your monthly debt payments. (Learn more about back end DTI here.) They want to know if you can afford the monthly payments on a home when considered with all of your other monthly debt payments. The more debt you have, the higher your DTI.
If your back end DTI exceeds the limit set by your lender (typically 43% or less) your mortgage application may be turned down. Even if you are approved for a mortgage, your DTI may still affect your ability to obtain down payment assistance. (HomeOwnership down payment assistance programs require a maximum back end DTI of 42%.)
How is your student loan debt calculated into your DTI? Lenders may use one of two different methods to determine your student loan payment on your DTI.
- The 1% method: Some lenders simply determine 1% of your total student loan debt and use the resulting figure as your student loan’s contribution to your back end DTI. This method may work against you, especially if you are on an income based repayment program or have extended your student loan term beyond ten years.
- The actual payment method: Using this method, the lender uses your actual monthly student loan payment as input to your back end DTI.
Which method will be used? That depends on a lot of factors. Are your loans in deferment? Are you on an income based repayment plan? What kind of mortgage will you have (FHA, VA, conventional, USDA, etc. Determining the method used can be complicated, so don’t be shy about asking lenders how they will consider your student loan payments when calculating your back end DTI.
None of this is to say that you can’t buy a home when you have student loan debt. People with student loans buy homes every day. However, having a lot of student debt can be a big road bump for may people on their road to homeownership.