Buying a house with student loans: How debt affects your eligibility and budget

Gina Pogol
The Mortgage Reports contributor

Can you buy a house with student loans?

Student debt can feel like a big obstacle for first-time home buyers.

Many would-be buyers aren’t even applying, worried that their debts will make homeownership impossible.

But the truth is that homeownership and student debt aren’t mutually exclusive. You can buy a home, get approved for a mortgage loan, and still make good on your student loans.

The trick is to understand how mortgage lenders look at your debts and plan your budget accordingly. Here’s how.

Verify your home buying eligibility (Oct 27th, 2021)

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Buying a house with student loans

Student loans shouldn’t stop you from buying a house as long as you have stable income and decent credit. If you can afford rent while you’re paying off student loans, there’s a good chance you can afford monthly mortgage payments.

But before you apply, it’s important to understand how student loans will impact your mortgage application — and what you can do to improve your chances of qualifying.

Here’s a quick overview of what you need to know. We’ll go over each point in more detail below.

  • When you apply for a mortgage, the lender will evaluate your debt-to-income ratio (DTI), which indicates the percentage of your monthly income required to repay your debts. Your student loan payments will be included as part of your monthly debts
  • By reducing your monthly debt obligations, you’ll reduce your debt-to-income ratio. This can increase your qualified mortgage loan amount and home buying budget
  • To do this, you can switch to a graduated repayment plan; request a longer loan student loan repayment period; or focus on reducing other monthly debt like credit card payments
  • There are a number of mortgages that work well for borrowers with student debt, including the FHA loan, the Fannie Mae HomeReady mortgage, and the VA loan. These programs may allow 100% financing, low-down payments, and more

Yes, your student loan debt will affect your mortgage eligibility. Your home buying budget likely won’t be as large as it would if you were debt-free.

But thanks to today’s flexible mortgage programs, you don’t have to wait until your debt is paid off to buy a home.

If you qualify, you can buy a home now, stop paying rent, and start building equity. Then you can upsize to a bigger home once your debts are paid off, if you want.

Verify your home buying eligibility with student loans (Oct 27th, 2021)

How your mortgage eligibility is determined

As a home buyer, your ability to get approved for a mortgage is based on three main factors: your down payment, your credit score, and your household income relative to your household debt.

Other traits matter, too, such as your employment history and assets. But these three are the most important.

Down payment

Down payments matter because the size of your down payment determines which mortgage loans you might be eligible for.

For example, the VA mortgage and UDSA mortgage both allow 100% financing. So if you qualify for either of these programs, you don’t need any money saved up for a down payment. (Although you’ll still need cash for closing costs.)

However, with no down payment, you would not be eligible for an FHA mortgage — which requires 3.5% down — or a conventional loan, which requires at least 3% down.

Credit score

Your credit score and credit report matter for the same reason.

All mortgage programs require that buyers meet a minimum credit score requirement. For some programs, minimum credit scores are high. For others, they’re low.

Generally, you can get approved with a FICO score above 580 as long as you meet other loan program requirements.

Debt and income

Your debts might be even more important than your down payment or credit score when it comes to your home buying budget.

Mortgage lenders don’t look at debt on its own. They look at it in relation to your monthly income.

Known as your ‘debt-to-income ratio’ (DTI), this calculation is believed to be the best predictor of whether you can actually afford to buy.

Why? Because your debt-to-income ratio shows a lender how much money you have left over each month after paying obligations like auto loans, credit cards, personal loans, and — yes — student loans.

The more of your budget that’s taken up by these other debt payments, the less cash you have left for mortgage payments.

Lenders will use your DTI to determine the maximum mortgage payment you qualify for — and, in turn, how much you can afford to spend on your new home. 

Check your home buying budget (Oct 27th, 2021)

Student loans and mortgage approval

Student loans are the biggest debt many first-time home buyers carry. They can have an outsized impact on your mortgage budget compared to other forms of borrowing like credit cards.  

But how do you actually crunch the numbers and figure out whether you can afford to buy a home?

The first step is to determine your debt-to-income ratio, factoring in student loans and any other debts you pay month-to-month. (You can see a full list of debts that are and aren’t included in your ratio here.) 

The basic DTI calculation is simple:

(Total Monthly Debt Payments) / Monthly Pre-tax Income = Your DTI

For example, say your gross monthly income is $5,000. Each month, you pay $300 toward student loans, $250 on a car loan, and $200 on credit card minimum payments.

That means you’re spending a total of $750 — or 15% of your income — on monthly debts.

Lenders typically want to see a DTI of 43% or lower when your housing costs are added to your existing debts.

Here’s how a 43% DTI works out with a $5,000 monthly income.

  • Maximum DTI: 43% (0.43)
  • 0.43 x $5,000 = $2,150

So $2,150 is the most you can spend on monthly debts including housing. You can work backwards from this number to estimate your maximum mortgage payment. 

  • Maximum debt payment: $2,150
  • Existing debts: $750
  • $2,150 – $750 = $1,400
  • Maximum mortgage payment: $1,400

Now you know you can likely spend up to $1,400 each month on your mortgage.

Next you can use a home affordability calculator, plug this number in, and find out how much house you might be able to afford.

Keep in mind, mortgage payments also include property taxes and homeowners insurance, so you need to factor in those things to estimate your budget correctly. A good mortgage calculator (like the one linked above) will include taxes and insurance to give you a more accurate estimate.

What if I have a lot of student loan debt?

In general, your DTI must be 43% or less in order to get mortgage-approved.

However, some loan programs are more lenient when it comes to DTI.

For instance, the Federal Housing Administration allows a DTI up to 50% for borrowers using an FHA loan. And Fannie Mae’s HomeReady program — intended for low- and moderate-income borrowers — may allow a DTI up to 45% or 50%. 

‘Compensating factors’ like a higher credit score or bigger down payment may be required to qualify with a high DTI.

You also need to find a lender willing to be flexible. Mortgage lenders get to set their own DTI limits, and not all of them will go up to the maximum allowed by a given loan program.

If you find the right loan program and lender, though, you could get approved with an above-average DTI, giving you more wiggle room if student loans are eating into your budget.

This could make all the difference in qualifying with high student loan debt.

You don’t have to max out your DTI

Even if a lender will accept up to 45% or even 50% DTI, you don’t have to use the full allowance. You may find this figure to be too high for your tastes, and that’s okay.

There is no rule that says you have to use the entire 43-50% of your household income on debts. You may prefer to be closer to 33% DTI, which is the range most financial planners recommend for housing costs.

For first-time buyers with student loans, however, using every available piece of DTI may be necessary.

This is because student loans can eat into your budget and redirect monies you’d rather be putting toward housing.

For example:

  • Assuming a monthly income of $5,000 and a 43% DTI, a first-time home buyer with student loans, credit cards, and a car payment can afford a home for around $240,000, assuming a low-down payment FHA mortgage
  • At a 33% DTI, the same income only buys a house around $130,000

This is how student loans can affect your mortgage loan approval. The more student loans you carry, the less home you can afford.

But student loans don’t have to be a barrier to entry. You may be able to reduce your monthly student loan payments, which can help you with your home loan approval.

Check your home buying budget (Oct 27th, 2021)

Advice for buying a house with student loan debt

Student loans affect your monthly budget which, in turn, affects your DTI.

There are ways to reduce your monthly student loan payments, which could improve your chances at mortgage approval. However:

Lenders may calculate your DTI based on a higher student loan payment than you actually pay each month. This might be the case even if you pay nothing at all.

If you’re in one of the modified repayment plans below, the most important thing is to shop with multiple lenders, and look for one that will work with you to understand your options and get approved.

Qualifying with a standard repayment plan

Under the standard repayment plan, monthly student loan payments are fixed and your debt is typically paid off in 10 years.

As the Federal Student Aid site points out, “payments may be slightly higher than payments made under other plans” because you’re repaying more of the loan principal each month.

Higher student loan payments mean a higher debt-to-income ratio.

So if you have large student loans, following the standard repayment plan could make it more difficult to qualify for a mortgage.

The good news, though, is that lenders will have an easier time approving you because your monthly payment ‘in real life’ is your monthly payment for qualification. This is not the case for other repayment types.

Qualifying with deferred student loans

Under special circumstances, borrowers might qualify for student loan deferment or forbearance. This means payments are postponed for a period of time (although interest can still accrue on the loan).

If your student loans are deferred, you might think your mortgage lender would ignore them completely. After all, you’re not making monthly payments, so it seems like you could avoid the DTI issue altogether.

However, mortgage lenders take a different view.

Due to rule changes in recent years, most loan programs no longer allow lenders to ignore deferred student loans or loans in forbearance.

Instead, they’ll often calculate a minimum payment based on your outstanding loan balance.

For instance, FHA and USDA lenders will either use the full payment listed on your credit report, or estimate a monthly payment of 0.5% of your loan balance, whichever is greater.

If your deferred loan balance is $20,000, for example, lenders will include a $100 (0.5%) monthly ‘payment’ in your DTI — even if your real payment is $0.

Fannie Mae and Freddie Mac use a 1% estimated payment for conventional loans.

The VA loan program is most lenient of all. As long as you can document that your deferred payments won’t start for at least 12 months, VA lenders do not have to count the student loan toward your DTI at all.

Qualifying with an income-driven payment plan (REPAYE, PAYE, IBR, ICR)

For home buyers with lower income, an income-driven repayment plan could potentially be the most helpful when qualifying for a mortgage.

Depending on the plan, your payments will be capped at a certain percentage of your discretionary income.

“Depending on your income and family size, you may have no monthly payment at all,” says the Federal Student Aid site.

In this case, lenders actually can ignore your student loans on your mortgage application.

Fannie Mae says that for conventional loans, lenders can use a $0 student loan payment for borrowers who document that their payment actually is $0 under an income-driven repayment plan. Again, you have to find a lender willing to go through the extra steps and document your $0 payment correctly.

Governmentbacked FHA, VA, and USDA loans may still calculate a payment as high as 0.5-1% of your loan balance.   

Graduated payment plan

You might also ask your student loan servicer about a graduated repayment plan.

A graduated repayment plan means your student loan payments start low, then rise every two years to meet the rising income of a typical college graduate.

With lower monthly payments, your debt-to-income ratio is reduced, which could potentially help you qualify for a home loan.

However, some lenders may use future payments for qualification. So be upfront with your lender about your graduated payment before applying.

How to reduce monthly payments before you apply

Loan consolidation is another way to reduce your monthly student loan payments.

You might have multiple student loans, all with various loan balances and different interest rates. By consolidating these into a single loan, you can lump your principal balances together, hopefully at a lower interest rate. This would reduce the total amount of interest you’re paying each month.

You can also request a longer loan repayment period, known as your ‘loan term.’

By lengthening your term to 15 years or 20 years, you can reduce the amount that you owe each month, which lowers your DTI. This will increase the long-term interest cost of your student loans, but will lower your monthly obligation.

Verify your home buying eligibility with student loans (Oct 27th, 2021)

Other ways to lower your DTI

A final option doesn’t relate to student loans at all — but, rather, credit card payments and other monthly debts.

If graduated payments and student loan debt consolidation don’t make sense for you, consider reducing your high-balance credit cards or any other debt which carries a high monthly payment.

For example, if you have a credit card which requires a minimum monthly payment of $150, and that’s more than your other credit cards, you can reduce that card’s balance. This will reduce the monthly payment due and helps to lower your DTI.

Lenders look at your cumulative debts. Reducing any amount you owe will positively impact your DTI.

In fact, federal student loans often carry much lower interest rates than other forms of borrowing. So if you have high-interest credit card debt or personal loans, it might make sense to look into reducing those first as a means to lower your DTI.

Mortgage options for buyers with student debt

As a first-time home buyer with student debt, there are a number of mortgage loan programs well-suited for your needs.

Many allow for low-down payment, and you might qualify for 100% financing as well.

The FHA loan, which is backed by the Federal Housing Administration (FHA), allows for a down payment of just 3.5% for borrowers with a credit score of 580 or higher.

FHA loans typically allow debt-to-income ratios of up to 43% but will allow higher DTIs on a case-by-case basis.

You can also use the FHA home loan if your credit scores are below 580, but a larger down payment of 10% is required.

The Fannie Mae HomeReady mortgage is another loan available to borrowers with student loans. Via HomeReady, buyers can show a debt-to-income of up to 50% with compensating factors, and a down payment of just 3% is allowed.

The minimum credit score to get approved for a HomeReady home loan is 620.

Buyers with military experience who have student loans should also consider the VA Loan program backed by the Department of Veterans Affairs.

VA loans allow for 100% financing and, according to loan guidelines, the maximum debt-to-income of 41% can be over-ridden if some of your income is tax-free income; or, if your residual income exceeds the acceptable loan limit by twenty percent or more.

Compare mortgage options (Oct 27th, 2021)

Down payment assistance

High monthly debt could also make it difficult to save for a down payment and closing costs.

In this case, look into down payment assistance programs (DPA) that could help you out.

DPA programs offer forgivable loans or an outright grant to help you cover the upfront costs of home buying. There are programs available in every state, and they’re often tailored toward first-time home buyers with moderate credit and income.

You can ask your loan officer, Realtor, or real estate agent to help you find DPA programs for which you might qualify.

What are today’s mortgage rates?

Today’s mortgage rates are at historic lows. That’s good news for borrowers with student loans.

While student loan debt might decrease your home buying budget, low rates actually increase the amount you can afford. So it’s in your best interest to shop around for the lowest mortgage rate you can find.

Compare mortgage offers from at least 3 lenders to be sure you’re getting the most out of your mortgage loan. You can start your pre-approval right here.

Verify your new rate (Oct 27th, 2021)