Are looking forward to owning a house? You should know that mortgage companies comb through your credit history to evaluate how much of a risk you are. As such, if you have an outstanding loan, qualifying for a new loan facility can be tricky. So, exactly how does student loan debt affect mortgage approval?
Basically, loan debts impact the two main factors that go into credit approval:
- Debt-to-income Ratio (DTI)
- Credit Score
How Student Loan Debt Affects Your Debt-to-income Ratio
Before your mortgage application can be approved, lenders check your financial records for your total debts against your income. This is what is known as the debt-to-income ratio. It factors your total monthly debt repayments and your pre-income total.
Total debts include all income deductions that appear on your credit record. Such include child support, student loans, auto loans, personal loans, and credit card payments. It follows that the more indebted you are the higher your DTI will be and the riskier you are to lenders.
Suppose your monthly income is $3,000 and a recurring debt of $1,200 monthly. Your DTI is 40% ($1,200 divided by $3,000). Generally, lenders look for a DTI of between 36% and 43% or less. So, in this scenario, you will be in a prime position of getting approved.
However, if your student loan pushes your monthly debt to $1,500, your DTI rises to 50% ($1,500 divided by $3,000), and getting a mortgage from a private institution becomes next to impossible. Your only reprieve is to try for a government-backed loan facility, such as FHA mortgages that accept up to a DTI of 50%.
Even then, you will be faced with stringent terms for the application to go through:
- Large down payment
- A large savings account or cash reserves
- Extra income apart from the one used during loan application. This could be part-time payment or income from a seasonal contract.
How Student Loan Debt Affects Your Credit Score
If you are looking for a mortgage then you must have come across credit scores. These are 3-digit numbers that sum up your creditworthiness. One of the main credit scoring services, FICO, summarizes your financial risk on a range of 300 to 850 points.
Typically, lenders accept credit scores of 670 and above.
Below that score, you present too much a risk and creditors will be less likely to approve your mortgage application. Also, your credit score determines the rates that are available to you.
A score of 670 – 739 is good and will get you an ‘okay’ APR (annual percentage rate). Between 740 and 799, your score is indicative of ‘very good’ credit and gets you a mortgage at a much lower APR. However, for the best rates in the industry, you need a score of 800 and above which is considered ‘exceptional’.
So, how does your student loan debt figure into all this? The answer has to do with how credit scores are calculated. Your debt repayment history accounts for 35% of the score and lenders look for consistent on-time loan payments.
Further, 30% of your credit score factors into the total amount owed in all of your accounts. Seeing that a student loan debt represents credit that was utilized and never paid, means that your finances are overextended. As such, in the eyes of lenders, you are more likely to miss your mortgage payments, or worse still, default.
Student loan debts present a challenge when shopping for a mortgage. For starters, you need to get on track with your payments so as to increase your credit scores. Also, consider getting a second job and keeping off new loans to reduce your DTI. Lastly, concentrate on growing your savings for when the time comes to put a down payment for your new home.