How Student Loan Debt Affects the Mortgage Approval Process

March 21, 2019 | By Brandon Cornett | © 2020, QualifiedMortgage.org

Key points from this article:

  • Student loan debt can affect your mortgage approval by increasing your debt-to-income ratio.
  • It can also affect your credit score, depending on how you manage your payments.
  • It could limit your ability to save up for a down payment and closing costs.

Student loan debt can affect the mortgage application, underwriting and approval process in several ways. The two most important factors are (1) the amount of debt you have in relation to your income, and (2) whether or not you’ve kept up with your payments in the past.

Here’s what you should know about all these factors.

How Student Loan Debt Affects Mortgage Approval

Studies have shown that a lot of people who have student loan debt feel that it will prevent them from buying a house. In a paper published in January 2019, researchers from the Federal Reserve wrote:

“In surveys, young adults commonly report that their student loan debts are preventing them from buying a home. Our estimates suggest that increases in student loan debt are an important factor in explaining their lowered homeownership rates, but not the central cause of the decline.” 

Consumer & Community Context, a Federal Reserve report. January 2019.

But let’s be clear about something right up front. Student loan debt, by itself, doesn’t prevent a person from qualifying for a mortgage loan or buying home. It’s the amount of debt that’s matters most. Having too much of it can definitely cause problems for mortgage applicants.

Here are three of the ways that student loan debt could affect a person’s mortgage application and approval process.

1. It could push your debt-to-income ratio over the limit.

When you apply for a mortgage loan, the lender will review your debt-to-income ratio to determine your ability to repay the loan. This ratio, which is typically expressed as a percentage, shows how much of your income goes toward your recurring debts.

For example, if a person spends 35% of her income on recurring monthly debts, she has an overall debt-to-income (DTI) ratio of 35%.

This is another area where student loan debt can affect the mortgage underwriting and approval process. In short, a person who carries too much debt relative to their income could have a harder time qualifying for a home loan.

The question is, how much is too much? This will vary from one lender to the next, and also depending on the type of loan being used.

These days, mortgage lenders tend to limit borrowers to a maximum DTI ratio somewhere between 43% and 50%. But they also might allow a slightly higher debt-to-income ratio for borrowers who have certain “compensating factors” in their favor. So those figures aren’t set in stone.

For example, a person with a relatively high debt load might still qualify for a home loan if he or she has a long history of making payments on time. Similarly, a person who makes a larger down payment and/or has more money in the bank might still qualify for a mortgage — even with a high debt load.

2. It can limit your ability to pay for closing costs and down payment.

Student loan debt can affect the mortgage approval process in other ways as well. It can also make it harder for would-be home buyers to save enough money to cover their down payment and closing costs.

A home buyer’s closing costs can easily add up to thousands of dollars. This is especially true when a mortgage loan is used to finance the purchase. On average, buyers tend to pay somewhere between 2% and 5% of the purchase price in closing costs. Having a lot of student loan debt can hinder a person’s ability to cover these mortgage-related costs.

In some cases, a home buyer might persuade the seller to contribute money toward their closing costs. This is common in slower real estate markets where sellers tend to be more motivated and flexible.

Additionally, mortgage lenders sometimes offer to pay some or all of the borrower’s closing costs, in exchange for charging a higher interest rate.

But in most scenarios, the buyer has to pay something on closing day. A person who is living “paycheck to paycheck” (partly as a result of their student loan debt) will have a harder time paying for these upfront expenses.

The down payment is another important consideration. And student loan debt plays a role here as well.

The down payment on a home purchase might range from 3% to 10% of the purchase price. Or even more, depending on the type of loan and other factors. A person grappling with a high level of debt would have a hard time saving up for this upfront investment.

The good news is that there are low-down-payment mortgage programs available for people with student loan debt (or anyone else who qualifies).

  • These days, conventional loans allow eligible borrowers to make a down payment as low as 3% of the purchase price.
  • The FHA loan program allows for a down payment of 3.5%.
  • VA loans for military folks enable home buyers to finance 100% of the purchase, for no down payment whatsoever.

Additionally, borrowers can often use money gifted to them from a third party to cover their upfront expense. So depending on the scenario, the down payment might not be as much of an obstacle as you think.

3. It can affect your credit score.

Student loan debt can also affect the mortgage application and underwriting process by altering your credit score — for better or worse.

Mortgage lenders use credit scores as part of their risk-analysis process. Generally speaking, a lower score represents a high-risk borrower, while a higher score indicates a lower risk to the lender. That’s because these scores are largely based on a person’s past payment history.

People who typically pay their debts on time and in full tend to have higher credit scores. Mortgage lenders view these people as less of a risk, and are more likely to lend money to them.

People who have a pattern of late or missed payments in the past tend to have lower scores, and are seen as a bigger risk.

This is another area where student loan debt could affect a person’s ability to get a mortgage loan. And it can go one of two ways.

  • Making your student loan payments on time can actually boost your score, and that might increase your chance of qualifying for a home loan.
  • On the other hand, being late or delinquent on student loan payments could lower your score and make it harder to get a mortgage.

You might have noticed a recurring theme here. Student loan debt by itself is not necessarily a dealbreaker, when it comes to applying for a mortgage loan. It’s the amount of debt that’s important to lenders, along with the person’s payment history.

If a person’s debt-to-income ratio falls within the lender’s parameters (and they’ve generally made their payments on time in the past), they might be a strong candidate for a mortgage loan.

If the DTI ratio is too high, and/or the person has a pattern of missing payments in the past, they will likely have a harder time getting approved for financing.

Three Things You Can Do Right Now

You can’t wave a magic wand and make your student loan debt disappear. (If only.) But you can take certain steps to improve your chances of qualifying for a mortgage loan and buying a place of your own.

1. Find out where you stand right now.

Maybe your debt-to-income ratio falls within the acceptable range used by mortgage lenders. Or maybe it doesn’t. You won’t know until you determine where you stand.

You can use a debt-to-income calculator to find out where you are, in terms of your overall DTI ratio. There are many of these calculators available online.

2. Consider buying a more affordable home.

Home buyers sometimes overestimate their financial capacity, when they first start shopping for a house. Often, a person will discover that the mortgage amount they qualify for is not enough to purchase the kind of home they want.

It’s a harsh reality of the lending world. You can only buy what you can afford, and your student loan debt will affect your ability to obtain mortgage financing. If this is true for you, it might be time to dial back your expectations.

Shopping for a more affordable home will reduce the amount of money you need to borrow, and will therefore make it easier to get approved for a loan in the first place.

3. Rent for a while and pay down your debt.

If you apply for a home loan and find that your student loan debt gets in the way, you’re probably better off renting for a while.

Among other things, this will give you an opportunity to gradually pay down your debts. It also gives you more time to save money for your closing costs and down payment.

If you do have to postpone your home-buying plans for a while, use the time wisely. Come up with a clear plan for reducing your overall debt load. Establish a budget. Scale back on your purchases and look for other ways to save money.

If buying a home is important to you, you’ll have to work for it.

Disclaimer: This article explains some of the ways student loan debt can affect the mortgage application, underwriting and approval process. Lending scenarios can vary widely from one borrower to the next, due to the many variables involved. So portions of this article might not apply to your particular situation. The best way to find out where you stand is to speak to a mortgage lender.