How to prevent student loan debt from killing your homeownership dream
What happens when the dream of homeownership meets the reality of student loan debt?
The results are startling:
- 83 percent of people age 22 to 35 with student loan debt who have not bought a house blame overwhelming loans – not their age or their careers.
- Student debt is responsible for up to 35 percent of the decline in homeownership among people ages 28 to 30.
- As student debt in the U.S. more than doubled over the past 10 years, homeownership has declined significantly.
The nation’s student loan debt grew to $1.4 trillion earlier this year, surpassing credit cards as the largest source of personal debt except for mortgages. For some college graduates, student loan payments can be as much or more than a mortgage payment.
Before you give up hope, here are three ways to prevent student loan debt from killing your homeownership dream.
1. Improve your debt-to-income ratio
The Consumer Financial Protection Bureau (CFPB) defines a debt-to-income ratio as all of your monthly debt payments divided by your gross monthly income (the amount of money you earned before taxes and other deductions are taken out). For example, if you pay $1,000 a month for your student loan, another $600 a month for an auto loan, and $400 a month for credit card and other debts, your monthly debt payments are $2,000. If your gross monthly income is $6,000, then your debt-to-income ratio is 33 percent.
This is one of the fundamental ways that lenders measure your ability to make your monthly mortgage payments. The higher your debt-to-income ratio, the more likely you are to have trouble making monthly payments. According to the CFPB, a debt-to-income ratio of 43 percent or lower is typically required for a qualified mortgage.
Paying off your auto loan, credit cards and other debts can help lower your debt-to-income ratio. One way to do it is the debt snowball method. Here’s what you do. List all of your debts in order from smallest to largest. Pay off the smallest debt first while paying the minimum amount on your other debts. Then, add what you were paying on the first debt to the next one. As each debt is paid off, your cash flow increases, eventually making it easier to pay off the bigger debts.
2. Protect your credit score
Along with a low debt-to-income ratio, mortgage lenders also look at your credit score.
Resist the urge to fall behind on your student loan payments, or even worse, default on the loan altogether. This is one of the worst decisions you can make if you ever hope to buy a home. The same is true for credit card debt.
Making ends meet right out of college can be difficult. Biweekly payments can make it easier to pay down your student loan and credit card debts faster plus save money on interest. The trick is to time the biweekly payments to coincide with when you get paid. How does it work?
Standard loans require one payment a month. Biweekly loan payments divide that payment in half and pay it every two weeks. Because there are 52 weeks in a year, you’re making 13 payments over the course of a year (instead of 12) with the extra payment applied to the principal. On a monthly basis, the payment amount is the same. However, the one extra payment a year can save hundreds to thousands of dollars in interest over the life of a loan.
3. Save for a down payment
Saving for a down payment is one of the biggest obstacles to purchasing a home. Conventional mortgages require a down payment equal to 20 percent of the home’s purchase price to avoid paying private mortgage insurance (PMI), which is a fee that protects the mortgage lender if you stop making your loan payments. That means saving $60,000 for a $300,000 home.
There are other mortgage options with lower down payment requirements, some as low as 3 percent, but even then, you’ll need a down payment of $9,000 for that same $300,000 home.
The Simple Dollar offers several tips on how to save for a mortgage down payment. They include:
- Open a savings account.
- Start a budget. Here are his four easy steps to learn how to make a monthly budget that works from one of our favorite sources for financial advice, Dave Ramsey.
- Check the interest rates on your credit cards, savings accounts, car loans, and other accounts and find out if you can do better.
Once you’re ready to make the dream of homeownership a reality, continue your education – no student loan required – with these three more things you need to know.