The desire to buy a house increased during the pandemic when people started to stay home more than ever. Both the need for more space and historically low mortgage rates stimulate this desire. However, before getting more student loan debt to buy a house, borrowers should think twice.
Due to the mentioned reasons, experts believe that home sales will peak in 2021. On the other hand, many people are looking for cheaper accommodation options to save money. As more than 40 million people have student loans, it is still questionable whether the buyers will be able to afford the house costs.
There are different ways that student loans affect home purchases. Student loan borrowers who bought houses mentioned that it took them around two years to save money for the down payment. Besides, student loan borrowers need to consider the upcoming increase in their debt ratio and ability to afford loan payments.
Dealing with Down Payment
In general, it is advisable to save money to cover 20% of the house price as a down payment. In this way, borrowers will not be obliged to pay private mortgage insurance. Besides, the interest rate will be lower due to the 20% value paid.
However, in competitive markets, more percentage of the house value as a down payment can be necessary. Borrowers usually find that it takes around two years to save funds to afford down payment, as mentioned above. Yet, depending on the market’s competitiveness, student loan debtors might need more time to collect the funds.
Evaluate Your Finances
Before rushing to take advantage of low mortgage interest rates, borrowers need to have a clear picture of their finances- income, utility expenses, medical bills, existing loan payments, etc. Borrowers should not ignore the possibility of late or missing payments. If they miss the payment, they will face penalties, and their credit scores will fall. Usually, creditors inform credit reporting agencies if 90 days pass the federal loan payment due date. For private loans, it can be as short as 30-45 days. Although your aim of purchasing a house is valuable, you should not ignore the existing loan obligations.
What is the Debt to Income Ratio?
Student loans have a significant impact on the borrower’s debt-to-income ratio. This ratio is calculated by dividing total monthly debt payments by monthly gross income. Keep in mind that gross income is the income level before tax and other similar deductions. Let’s see an example.
The borrower’s gross monthly income is $8,000. The borrower pays a loan for an automobile, which is $1,200, and $150 for student loans. The rest of the debt, like a credit card, etc., requires $350. In this case, the debt-to-income ratio is 21.3%:
($1,200+$150+$350)/$8,000=0.2125 (around 21.3%)
It is usually advisable to have a debt-to-income ratio of less than 43%, according to the Consumer Financial Protection Bureau. However, each lender can have their requirements for this ratio. Hence, depending on the lender/creditor, the threshold can be lower. The lower the debt-to-income ratio, the more opportunity borrowers have for additional loans.
When getting a mortgage loan, the lenders will check the debt ratio. Even if your ratio is around 40%, you might not be qualified if the lender desires a maximum of 25%. Therefore, having student loans can make it harder to get an affordable mortgage.
Find Student Loan Debt Reduction Alternatives
Besides evaluating the finances, student loan borrowers should explore their options to reduce or eliminate the debt obligation. For example, refinancing can help borrowers to lower their monthly payments. Moving to a more affordable repayment plan can also be a solution.
However, do not rush to get rid of debt obligations. Sometimes, it is a better idea to refinance or progress toward the Public Service Loan Forgiveness rather than paying out the debt. Borrowers need to explore all possible alternatives and conduct an accurate analysis of benefits and costs.
Besides, if the current student loans have low-interest rates, the borrowers might use excess funds to make higher payments. Yet, utilizing the budget surplus for investment purposes like retirement accounts can be a more beneficial idea in the long run.
How to Reduce Student Loan Debt Obligations?
If you have federal loans, it might be useful to consider federal programs to reduce or eliminate the debt. The government provides multiple options for this aim.
Multiple forgiveness options exist which can cancel some portion of the debt. If you serve in the public sector, you can apply to the Public Service Loan Forgiveness program. This program eliminates all debt once the borrower makes 120 payments. Another useful program is Teacher Loan Forgiveness, which can bring $17,500 or $5,000 student debt cancellation.
Borrowers who faced misleading activities such as false advertising or incorrect job replacement rates can apply to Borrower’s Defense to Repayment program. This program can eliminate up to 100% of the debt if the borrower can prove the case to the Education Department.
Besides forgiveness, discharge opportunities exist for disabled debtors or those whose schools close. Discharge due to bankruptcy, death, or false certificate is also accessible.
If eliminating the debt is not possible, it is time to find other programs that can at least reduce the debt burden. For example, moving to a more affordable debt repayment plan can help borrowers save money. Specifically, income-driven repayment plans can be suitable for people with low incomes.
Consolidating or refinancing the student loans can serve the same purpose. They will not erase the debt, but they will help debtors pay out the student loan effectively. You can get more information about these programs in our blogs.
What about Private Loan Borrowers?
Unfortunately, the private borrowers do not have access to many debt resolution options as federal borrowers do. However, they can benefit from a few programs to reduce the debt obligations.
Refinancing is one of the programs private borrowers qualify for. Loan refinancing involves getting a new loan to pay out the existing debt. Usually, the new loan has better loan terms like reduced interest rate, which makes the debt repayment easier.
In extreme cases when the private borrower cannot repay the debt, debt settlement can be a solution. In this process, the borrower stops making payments and collects money. After some time, a debt settlement company contacts the lender to convince them to a lump-sum amount. Sure, this amount is less than the original student loan debt, but lenders can accept this idea as they will receive a lump-sum amount rather than small payments. If the student loan obligations are reduced, purchasing a house and getting favorable mortgage loans can be more accessible.