Housing and the Student Debt Issue
How student loan debt affects first-time homebuyers and what they can do about it.
by Myles Biggs
As the month of May quickly approaches, the next wave of
college graduates will soon enter the work force. Between entry-level jobs, consistent
diets of ramen noodles and minimalistic apartment décor, these graduates will do
their best to budget and save their money so that one day they can realize their
own American Dream of home ownership.
However, thanks to the increasing burden of student-loan debt,
many of these graduates believe that they cannot afford a mortgage. According
to the Pew
Research Center, the average student debt per household was $26,682 in
2010. That’s up from $17,562 in 2001 and $9,634 in 1989.
The truth – while rising student debt is indeed an issue,
the bigger issue is fear of the unknown – not everyone takes a class on
planning for a mortgage in college. It is important that we focus less on
daunting statistics and more on arming these graduates with an appropriate
understanding of how mortgage approvals work. Once graduates are aware of the
factors affecting their mortgage approvals, they can put fear aside and start
to adequately prepare for their future.
Understanding Your Debt-to-Income Ratio
As a recent graduate, lenders are not as concerned with the
total amount of your student loan debt as they are with your total monthly debt
payments and how they compare to your income. This comparison is known as your
debt-to-income ratio (DTI). Lenders will calculate both a front-end DTI and a
A front-end DTI compares your monthly housing expenses
(mortgage payment, property tax and homeowner insurance premiums) to your
income level. A back-end DTI compares your other debt responsibilities (minimum
credit card payments, car loans and any other debt responsibilities) to your
front-end DTI and your income level.
As a rule of thumb, lenders prefer a front-end DTI of less
than 31 percent and a back-end DTI of less than 43 percent.
You can calculate your front-end DTI by dividing your
monthly housing expense by your gross monthly income. Your back-end DTI would
be your monthly housing expense plus any additional debt amounts (minimum
credit card payments, car loans, etc.) divided by your gross monthly income.
Understanding Your Options
There are several different types of mortgages available. Most
potential first-time homebuyers do not have the same access to capital as
move-up homebuyers do. If you are a potential first-time buyer concerned about
affording a large down payment, you may want to research loans from the Federal
Housing Administration (FHA).
FHA loans offer home buyers more flexibility with their down
payment and often accept down payments of as little as 3.5% or less. Unlike
traditional mortgages that require a solid down payment of 20% or more, these
loans require mortgage insurance, often built into the principle and
incorporated into monthly payments. Buying with a down payment of 3.5% means
that do not have a high equity investment in the property. This mortgage
insurance helps to protect the lenders in the event that you walk away from the
loan and leave the property.
While low down payments may be enticing, they are also the
reason why many homeowners end up underwater and homes go into foreclosure. Therefore,
first-time buyers need to be particularly cautious about taking on a mortgage
that is greater than what they can afford.
If your DTI does not fall within the favorable range, it is
wise to pay down your student loan debt before you assume further debt in the
form of a mortgage. Consider addressing your student debt in the following
your income – a higher income will result in a more favorable DTI,
improving your chances for mortgage approval. Additional income will also allow
you to put more money towards your loans, effectively lowering your total debt
amount and helping your DTI. Increase your income by picking up a side job,
engaging in professional freelancing or by simply asking for a raise from your
larger payments – this is the best options for those graduates who are
still living with their parents and have little to no renting expense. Consider
putting the money you are saving on rent into paying down your loans. This will
lower your debt faster, reduce money spent on interest and get you near the DTI
you need for a mortgage.
your interest rates – you can reduce the interest rates on your student
loans through direct withdrawal and consolation programs. Reducing interest
rates by even a fraction of a percent can make a huge difference and save you
tens of thousands over the life of a loan. Lower interest rates often mean
lower monthly payments, which will help your DTI and improve your chances for
Within a Budget – proper management of your finances is the easiest way to
make the most out of your money. By watching your flow of money in and out, you
can identify areas of excess and unnecessary spending. You can then take the
money you save in various areas and apply it to your loans – slowly but surely digging
yourself out of debt.
Knowledge is power. We encourage you to take these basic
points and use them to jump start your own financial research and planning. Once
you are ready to buy your first home, we happen to know a company with several
attractive entry level floor
plans for you to check out.
Do you have additional insight into the issue of student
debt and first-time home ownership? Drop us a line in the comments section