Assuming you want to become a homeowner, it’s probably best to go to college, even if you have to take out costly student loans in the process.
You may have read articles over the past several years that talk about snowballing student loan debt and the inability to afford a mortgage as a result.
But it turns out you’re still more likely to buy a home if you obtain at least a bachelor’s degree.
The Benefits Outweigh the Costs
A recent commentary (since removed) from mortgage financier Fannie Mae revealed that those who go to college are more likely to become homeowners than those who simply graduate from high school.
The most likely are those with a college education and no student loans, with a likelihood of homeownership that is 43% higher than high school graduates without student loans.
Meanwhile, student loan holders with bachelor’s degrees are still 27% more likely to become homeowners relative to those debt-free high school graduates.
There is a catch though – if you don’t actually complete your bachelor’s degree and simply wind up with student loans, you’re actually worse off than those who simply called it quits after high school.
This last group is 32% less likely to own a home than a debt-free high school graduate. They’re also more likely to be behind on student loan payments, which isn’t very surprising.
The takeaway here is that it pays to go to college, even if it costs and arm and a leg. The idea being that college grads get paid more and are eventually able to qualify for mortgages to purchase homes.
There is a caveat though. Student loan debt has increased substantially in recent years and its effects may not yet be evident in the homeownership numbers. Additionally, the majority of those surveyed by Fannie Mae had student loan debt that accounted for 10% or less of their monthly income. Others might not be so lucky.
Don’t Be Discouraged If You Have Student Loans
If you have outstanding student loans, you can still get approved for a mortgage. It just might affect how much you can afford because it will be factored into your DTI ratio.
Many student loans are deferred to help recent graduates get up and running before they are gainfully employed. However, mortgage lenders know these individuals will eventually have to repay their loans.
As a result, lenders must still account for the student loan repayment when qualifying you for a mortgage to ensure your home loan is actually affordable.
Of course, it depends on the type of mortgage you apply for.
Fannie and Freddie Student Loan Guidelines
When it comes to Fannie and Freddie (conforming loans), if the student loan payment amount is listed on the credit report, it can be used for qualifying purposes. End of story. Well, it was the end of the story until Freddie Mac changed their guidelines.
If the payment isn’t listed on the credit report, or shows $0, or is deferred, then 1% of the outstanding balance is used to determine the monthly payment. So if it’s a $25,000 student loan, $250 is added to your monthly liabilities.
This used to be 2%, or $500, but Fannie determined that actual monthly payments were generally less than 2% of the total balance.
The old policy also required lenders to use the greater of the actual monthly payment or 1% of the balance, unless the payment was fully-amortized and not subject to any future adjustments. But this made no sense either.
Lenders are also able to calculate a payment that will fully amortize the loan based on the documented loan repayment terms, which may result in a lower monthly liability.
Freddie Mac can be a bit more forgiving in accepting the actual monthly payment so you may want to consider lenders with Freddie approval if you’re cutting it close.
Update: Fannie Mae now allows lenders to qualify borrowers with a $0 student loan payment as long as the $0 payment is associated with an “income-driven repayment plan.” However, the lender must obtain documentation to prove the monthly payment is really $0.
FHA Student Loan Guidelines
For the FHA, if the student loan is deferred and no payment is on your credit report, you will be on the hook for 1% of the total balance. So if the total is $50,000, the lender will factor in $500 per month into your DTI ratio. Obviously this can have a huge effect on what you can afford.
The good news is the requirement used to be 2% of the outstanding balance if no payment was found. So in our example it was $1,000 per month. The bad news is that the FHA no longer allows the income-based repayment (IBR) amount to be used.
If the actual monthly payment is less than 1% of the balance, you need to document it and prove it is fully amortized.
VA Student Loan Guidelines
When it comes to VA loans, student loan payments can be ignored if payments won’t begin for more than 12 months from loan closing. Otherwise you have to count the actual or anticipated monthly payment.
USDA Student Loan Guidelines
For USDA loans, the actual student loan payment can be used if it’s fixed (and has a fixed term) without future payment adjustments. If no payment is reported or it is deferred, 1% of the loan balance is used unless there is evidence that it’s a fixed payment.
If you’re close to maxing out with regard to DTI, an experienced mortgage broker or lender might be able to get you a mortgage using a mortgage that has a more forgiving policy with regard to student loan debt. So don’t simply give up until you exhaust all your options.
But also make sure you factor in any student loan debt early on in the mortgage discovery process so you don’t overlook a key qualification aspect.
A good rule of thumb might be to calculate your DTI using 1% of your student loan balance for the monthly payment, even if it turns out you can use a lower actual payment. That way you still qualify in the worst-case scenario.
Also watch out for lender overlays that call for higher minimum monthly payments than the guidelines actually require.