October 2, 2020

What to Do if Your Student Loans Makes it Hard to Get a Mortgage

What to Do if Your Student Loans Makes it Hard to Get a Mortgage


Despite the coronavirus lockdowns, or helped by them perhaps, much of the U.S. is in the midst of a red-hot housing market. But buying a home can be challenging if you have student debt.

More than 44 million Americans collectively owe around $1.6 trillion in student loans, according to Federal Reserve and New York Federal Reserve data. With mortgage lenders increasingly tightening their lending standards to provide more cushion against borrower default, buying a home could be more difficult for many student-loan holders.

Here are some strategies that could help people who are carrying student-loan debt qualify for a mortgage.

1. Improve your debt-to-income ratio

When mortgage lenders evaluate borrowers, they look at two debt-to-income ratios. The first, called the front-end ratio, compares an applicant’s expected mortgage with his or her monthly income. The second comparison, the back-end ratio, is where borrowers may have more wiggle room to help their cause. This ratio looks at an applicant’s monthly expenses, including housing, car payments, student-loan bills and minimum monthly payments on credit cards, compared with his or her monthly income.

By taking simple steps, such as paying down credit-card balances, borrowers can improve their chances of qualifying for a mortgage. Unlike with other debt where monthly payments are static, paying down the balance on a credit card will lower your minimum monthly payment.

“Each little bite you take at that pile of debt, you’re helping your debt-to-income-ratio,” says Michael Lux, founder of the Student Loan Sherpa, a website dedicated to student-loan education, strategy and borrower advocacy. Even better, he says, if you’re able to pay your credit-card balance in full each month, it won’t factor into your debt-to-income-ratio at all.

Another way to improve your debt-to-income ratio is to tweak your student-loan repayment options so that you are paying less each month. Mr. Lux suggests borrowers use the federal government’s Loan Simulator tool to estimate what their monthly payments could be under a different plan. Of course, there can be trade-offs to switching plans, such as paying more over the life of the loan. But for those who want to improve their debt-to-income ratio, it’s at least an option to consider.

Borrowers on income-driven repayment may find that some mortgage lenders automatically apply a fixed percentage of their loan balance when calculating the debt-to-income ratio, which could be higher than their actual monthly payment. This was far more common in the past, but borrowers most likely to face this issue today are those who, based on their income, make no monthly payments, Mr. Lux says.

Borrowers should ask prospective mortgage lenders how these calculations are made and be prepared to offer evidence of their actual monthly payment to lower their debt-to-income ratio. They could also choose to apply for a mortgage with a more flexible lender, Mr. Lux says.

Student-loan borrowers with private loans could also consider refinancing to get a lower monthly payment to improve their debt-to-income ratio. Such a move is likely to lengthen the repayment term, meaning you’ll pay more over the life of the loan. However, you may be spending only a little more in interest over the life of the loan in exchange for a lower mortgage rate, which can result in a bigger savings, Mr. Lux says. Borrowers with federal loans should be wary of this strategy, since by refinancing they would lose certain protections such as income-driven repayment and student-loan forgiveness, Mr. Lux says.

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Yet another option for borrowers is to eliminate smaller loan balances that carry a minimum monthly payment. While experts typically advise that borrowers pay down their highest-interest obligations first, an exception is for those trying to improve their credit score and debt-to-income ratio for mortgage-application purposes. When you pay a loan balance to zero, your credit score will improve and the debt will no longer factor into your debt-to-income ratio because there is no monthly obligation, says Martin Lynch, director of education at Cambridge Credit Counseling Corp., a nonprofit debt counseling organization in Agawam, Mass.

Things can get tricky for borrowers who have student loans that are in deferment or forbearance. That’s because some lenders use a fixed percentage, say 0.5% or 1%, of the outstanding balance in the debt-to-income ratio calculations. This, however, could be higher than a borrower’s actual payment would be, says Mr. Lynch. In this case, borrowers are advised to ask their student-loan servicer for an estimated payment letter, so their back-end ratio isn’t distorted, he says.

2. Borrow less

Making a larger down payment will help reduce the housing or front-end ratio used in the approval process, helping you qualify, Mr. Lynch says. “Saving for a larger down payment may only require temporary budgeting measures,” he says, and can be good for prospective homeowners, in the sense that, “if belt-tightening is needed to meet some future crisis, they know how to do it.”

You could also seek to buy a less expensive home, Mr. Lynch says. “You don’t want to jump into a situation where you are living paycheck to paycheck to afford the home.”

3. Seek to improve your credit score

Better scores earn lower interest rates and lower monthly payments, Mr. Lynch says. Borrowers can accomplish this by opening new accounts judiciously, paying on time, and keeping older accounts open to benefit from a longer average credit history and a larger amount of available credit.

4. Don’t change jobs without considering the impact on the lending decision

Taking on a higher-paying job seems like a no-brainer, but job stability is a factor for some lenders, who may want to see at least two years of service with your current employer, Mr. Lynch says. So, unless you would be substantially increasing your income, staying put in a job, at least until the home purchase is complete, can be helpful, especially for mortgage applicants who have student loans or other debt that may make qualifying more difficult, he says.

Ms. Winokur Munk is a writer in West Orange, N.J. She can be reached at reports@wsj.com.

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