As you finished up high school you began to say good-bye to your childhood years and were thrust into looking adulthood straight in the face. You probably were answering questions like “What do you want to be when you grow up?” with answers involving a specific career – like being a doctor, lawyer, teacher, accountant, etc. The answer you probably did not think of at the time was that you wanted to be a homeowner.
For many people, leaving high school means going on to further their education in college. With college tuition now being more expensive than it ever has been, choosing to further your education in college probably means student loans – and lots of them. In fact, the student loan debt crisis is so serious that many post-graduate students are now putting off buying a home because of the amount of their student loan debt. A recent poll conducted by the American Student Assistance group (ASA) found that approximately 71% of those with student loan debt are waiting to buy their first home because of their loan debt.
How does student loan debt affect a mortgage loan?
In addition to creating financial stress on the borrower, student loan debt can also make it more difficult for a borrower to qualify for a mortgage loan. Any time someone applies for a mortgage loan, the lender needs to consider your specific financial situation, and they will do this by requesting proof of your employment history and income, including your W-2’s and other tax forms, and will also want to see any outstanding debts you currently have such as a car loan, credit cards, and student loans.
Of all the outstanding debt you may have, student loan debt tends to affect your ability to qualify for a mortgage loan the most because the remaining balance is typically very large, and the repayment schedule is designed to be very long-term. However, just because you have outstanding student loan debt does not mean you will not be able to qualify for a mortgage loan. When applying for a mortgage loan, the lender will take into consideration your front-end and back-end debt-to-income ratios (DTI) to determine the amount of a mortgage loan you will be able to afford moving forward.
What are front-end and back-end debt-to-income ratios?
A front-end ratio is calculated by comparing your expected monthly mortgage payment to your gross monthly income (total income before taxes are taken out). This type of ratio is also know as the housing ratio. Your expected monthly mortgage payment will not only include the amount you will have to pay for your home, but will also account for interest, taxes, and homeowner’s insurance payments. This combined expected monthly mortgage payment is referred to as PITI (principal, interest, taxes, insurance). The front-end ratio is calculated by dividing the PITI by your gross monthly income to obtain a percentage. Ultimately, the acceptable percentage for a front-end ratio will be determined by the lender, but they typically range between 28% and 36%.
While the front-end ratio compares only your PITI to your gross monthly income, a back-end ratio is used for the lender to take into consideration any outstanding debts you currently owe. A back-end ratio is calculated by adding your current monthly financial obligations together and comparing the total to your gross monthly income. When calculating your back-end ratio, the lender will take into consideration not only the PITI payment, but also any other financial obligations you have such as credit card debt, vehicle loans, and student loan debt. The back-end ratio is thus calculated by dividing your monthly financial obligations by your gross monthly income to obtain a percentage. Typically, lenders will want the back-end ratio to be less than 36% if you are applying for a conventional loan and less than 41% for a FHA loan.
Other factors a mortgage loan lender will consider
While the front-end and back-end ratios are important when applying for a mortgage loan, they are not the only factors a mortgage lender will take into consideration. Other factors that can affect how your student loan debt impacts your mortgage loan application include:
- Your down payment – typically, it is recommended that you plan to make a 20% down payment on the overall cost of the home. The amount of your down payment will affect your front-end ratio because the more you put down the lower your PITI will be. This means if you are planning to put down the recommended 20%, you are unlikely to be affected by your outstanding student loan debt.
- Your income – although student loans mean you have a large outstanding debt, they also mean you probably have a degree that will help you qualify for employment in a position with a higher paying income.
- Your employment history – most lenders will use your employment history to determine your stability and will want to see a minimum of 2 years or more of work history. Some lenders even want you to have been employed with the same company or within the same industry during those 2 years or more.
As you can see, there are many factors that are taken into consideration which can help you qualify for a mortgage loan even if you do have student loan debt. In the end, you will need to take into consideration what your long-term goals are and your own level of comfort with having two large, long-term debts.