Can I buy a home if I have student loan arrears?

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Given that current mortgage rates are at historic lows, you might want to consider buying a home soon if you’re ready …

Given that current mortgage rates are at historic lows, you may want to consider buying a home soon if you are ready to take the step. But if you have student loan debt, you might be wondering if it might affect your ability to get a good mortgage deal or even buy a house at all. While it is true that too much existing debt can affect your interest rate and even whether or not you qualify for a mortgage, in most cases you can – and should – still consider buying a home if you are willing to.

Student loans do not affect your ability to obtain a mortgage in any other way than other types of debt you may have, including car loans and credit card debt. When you apply for a mortgage, your lender will evaluate all of your existing monthly payment obligations, including student loans, to determine if you can manage the additional monthly payment. Depending on your situation, the lender will decide if you are eligible for a new loan, and if so, at what interest rate.

[Read: See How Average Student Loan Debt Has Changed in 10 Years.]

For this reason, you should consider how both your monthly student loan payment and hypothetical mortgage payment might affect your debt-to-income ratio and overall credit rating before applying for a mortgage. In other words, if you have any existing debt, you need to be careful so that you can manage all of your monthly payment obligations with your current income.

This calculation varies slightly depending on the type of mortgage you choose.

Potential home buyers can choose between a regular mortgage from a private lender such as a bank or other financial institution, or an FHA loan, which is a mortgage secured and insured by the Federal Housing Administration for people with limited savings or a lower credit rating. This support allows the lender to offer you a better deal, which usually includes a lower minimum down payment and easier loan qualifications. Recent changes in how lenders are supposed to calculate monthly student loan payments could make an FHA loan a more attractive option for those with student loan debt, especially first-time home buyers.

As you consider your options, there are a few things you need to know about your debt-to-income ratio and credit rating.

Debt to income ratio

When you apply for a home loan, lenders use your debt-to-income ratio as a metric to assess whether you can manage all of your debt obligations and make monthly payments on the new loan.

The lender calculates your debt to income ratio by adding up all of your existing monthly debt payments and the expected mortgage amount. This number is then divided by your gross monthly income, or the amount you earn before taxes and other deductions, to determine what your debt-to-income ratio will be.

You can do this calculation before applying for a mortgage to better understand if you are eligible for a loan. For example, if you pay $ 500 a month on a car loan, $ 200 a month on student loans, and want to buy a home with a $ 1,300 monthly mortgage payment, your monthly debt payments would be $ 2,000. If your gross monthly income is $ 6,000, then your debt-to-income ratio is about 33% based on a $ 2,000 figure.

[Read: How to Buy a Home When You Have Defaulted Student Loans.]

For the purposes of this calculation, debt payments are the regular payments you are required to make to repay the money you borrowed. These include, for example, student loans, car loans, credit card debt, and mortgages. Other monthly expenses, such as utility bills and food bills, are not included in this calculation.

Most lenders will not approve a mortgage if the applicant’s debt-to-income ratio is above 43%. Experts believe that, ideally, it should be at the level of 36% or less, while the maximum for monthly mortgage payments should be less than 28%.

The main thing to know is that what matters in this calculation is the amount you pay each month, not the total amount of your debt. If you find that your debt-to-income ratio is too high to qualify for the mortgage you’re looking for, note that federal student loans offer some flexibility in the amount you pay each month. For example, you can try to switch student loan repayment plan from standard to graduated or extended to see if a lower payment lowers your debt-to-income ratio.

Just be aware that lowering your monthly student loan payment can increase the amount you will pay over time if you pay off your loan for a longer period of time and accumulate more. interest

For those considering an FHA loan, changes were announced in June 2021 that affect the way student loan debt is calculated as a debt to income ratio and make it easier for some prospective homebuyers with student loan debt to access FHA loans. Under the old rules, FHA lenders were required to calculate the borrower’s monthly student loan payment at 1% of the outstanding student loan balance. Under the new policy, the amount of the monthly payment used in calculating the debt-to-income ratio is the same as the actual payment on a prospective home buyer’s student loan, which is often lower.

According to the FHA, approved lenders can make these changes immediately, but must do so by August 16, 2021.

Credit rating

Existing debt, including student loans, can also affect your ability to qualify for a mortgage because lenders also look at your credit score. You increase your creditworthiness and improve your credit score by continually making monthly payments on time, including student loan payments.

[Read: 7 Apps That Can Help You Pay Off Student Loans.]

Lenders use your credit score and history to gauge the amount of risk they will take when providing you with a loan. High credit rating excluding delays or default values gives lenders confidence that you will pay off your new loan on time, while a low credit rating, including late or inconsistent payments, can make the lender more indecisive.

Lenders use your credit rating to decide if you are eligible for a mortgage and also to determine the interest rate on the loan. Borrowers with higher credit ratings are usually eligible for lower interest rates, while interest rates are higher for borrowers with lower credit ratings.

You can check your credit rating before applying for a mortgage through your bank or AnnualCreditReport.com, which is controlled by the Federal Trade Commission and the Bureau of Consumer Financial Protection. If you have a low credit rating, paying off your student loan on time is a great way to build and improve your credit and get your mortgage – with a good interest rate.

A low credit rating can be another reason to consider an FHA loan. FHA loans are available to individuals with a credit rating of 500 if they can afford a 10% down payment. However, if you have experienced a bankruptcy event, at least two years must pass and you must demonstrate that you are working on building a good credit history.

In the case of an FHA loan, the low credit rating will still affect the interest rate that is offered to you, so you may end up paying a higher mortgage rate. Also, keep in mind that if you miss your federal student loans, you most likely will not be eligible for an FHA loan.

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Can I buy a home if I have student loan arrears? originally appeared on usnews.com

Update 07/28/21: new information has been added to this article.

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