Budgeting for a Home Mortgage? Don’t Forget Your Deferred Student Loan
If you’re thinking about home ownership, you’re probably calculating how a mortgage payment will fit into your monthly budget. If you’ve postponed any student debt repayments through deferment or forbearance for 12 months or longer, are you factoring in that debt? These student loans may affect your ability to get the home mortgage you want, or result in a higher interest rate, based on federal changes that started in 2015.
What First Time Home Buyers Need to Know
Buying your first home is an exciting personal and financial milestone, but saving for a down payment can be challenging. That’s why government-insured Federal Housing Administration (FHA) loans are popular with first-time buyers — they provide low down payment mortgages. In fact, nearly 1 in 5 U.S. buyers currently have an FHA loan.
Before 2015, FHA mortgage applications didn’t factor in your payments on student loans deferred for more than 12 months. Now, lenders include either 1 percent of your student loan balance, or the actual monthly payment reported on your credit report — whichever is more — when calculating mortgage application debt-to-income ratios.
Why Your Debt-to-Income Ratio is Important
When you apply for a mortgage, your application typically includes a credit check, down payment and income verification, and a calculation called your debt-to-income (DTI) ratio. Your debt-to-income ratio represents the percentage of your monthly income that goes towards debt repayment. You can calculate your DTI by adding up all of your monthly debt payments (car payments, minimum credit card payments, student loan payments, child support/alimony and any additional debt obligations) and dividing that by your gross monthly income (before taxes and deductions).
Lenders use this figure to help decide if you can afford a mortgage. Most lenders prefer a DTI ratio with a maximum of between 43 and 45 percent — any higher, and you might be more likely to default on your payments.
So if your deferred student loan debt is $30,000, one percent of that is $300, which will be added to the monthly debt your lender includes on your FHA mortgage application. Since your debt is now higher while your income remains the same, your debt-to-income ratio may be over 43 percent, which could disqualify you not only for an FHA mortgage, but from most other lenderswhere the preferred DTI may be even lower.
When It Comes to Your Debt Repayment, Think Ahead
If you’re planning to buy your first home, these new federal rules are in place to help you understand how much money you might need to come up with each month once you start repaying your student loans. Even if you’re not currently making student loan payments, you don’t want to count on a higher income later — factor these payments into your monthly budget now to help determine if you can also afford a home mortgage payment.
What else can you do? Work to reduce your DTI by paying down debts and look to buy a home within the lower end of your budget to help reduce your monthly mortgage payments. You may have to adjust your home buying expectations, but understanding what you can really afford will help you plan a secure financial future.