Conquer your student debt. Refinance now.
Owning a home can be an enormous source of pride and independence, but if you have student loan debt, juggling a down payment and mortgage can take some strategizing.
According to Ashley Dixon, a Certified Financial Planner at Gen Y Planning, only a handful of her firm’s 90 or so client households have both student loans and a mortgage. “A lot of people are just so strapped [by their student loan payments], they feel they don’t have the opportunity to take on a mortgage,” Dixon says.
Dixon’s clients reflect a nationwide pattern: According to a 2019 survey, 61% of millennials say student loan debt has forced them to delay taking on a home loan. As for those who make the jump?
Case Study: a First-Time Homebuyer with $25K in Student Loans
For Liz Pecknold, buying a home just made sense. In 2016, she, then 25, and her husband purchased their new home in Nederland, Colorado, despite a student loan balance of $25,000.
“We were tired of renting and paying the mortgage for someone else’s apartment,” she explains. Plus, her husband was a veteran, which gave them additional mortgage loan opportunities. The pride of owning their own home has been worth it, Pecknold says, but it hasn’t been easy.
“There were a lot of costs we didn’t quite anticipate,” she says. On top of the mortgage, there were closing costs, insurance, property tax, and a heavy propane and electricity bill due to Nederland’s high elevation and cold winters. “For those first few years, we were barely breaking even,” Pecknold admits.
Careful budgeting helped the Pecknolds stay on top of their repayment plan, but they didn’t have enough left over to build much of an emergency fund. In the spring of 2020, Pecknold was looking for new work when the coronavirus pandemic hit—forcing many companies to put a freeze on hiring.
“Right now, if I’m being honest, I’m feeling very insecure about my financial future. We’ve talked about selling the house and living more simply,” she says, though the thought of giving up her home isn’t easy—“We were hoping to have a child sooner or later.” Now, that’s been put on hold for financial reasons.
“If I had to do it again? I don’t know,” Pecknold says of buying her home back in 2016. “I think I would have spent a little more time to have more savings and a little bit of a safety blanket.”
Still, balancing the monthly debt payments of both home ownership with student loans is possible, says Dixon. The secret lies in smart budgeting, a strong emergency savings plan, and paying off debts in the right order.
How to Get a Mortgage When You Have Student Loans
While a large percentage of millennials with student loans are choosing to delay home buying, you don’t necessarily have to wait until you finish your monthly student loan payments. That’s because mortgage lenders don’t just look at your loan amount. They consider your credit report, gross monthly income, and your debt-to-income ratio.
“If your credit score is excellent, then you should be able to receive a reasonable interest rate on a mortgage despite your student loan debt,” says Dixon.
As for debt to income (DTI), that’s the percentage of your monthly pre-tax income that you spend on debt repayments. This includes student loans, but also any car loans, credit card payments you are making, etc. So if you earn $4,000 per month, pay $400 per month on student loan payments, and have a projected mortgage payment of $1,200 per month, your DTI is 1600/4000, or 40%.
While mortgage lenders differ on what they consider an acceptable DTI, the Consumer Financial Protection Bureau gives 43% as the highest DTI at which most borrowers can receive a Qualified Mortgage. A Qualified Mortgage is a mortgage loan with certain protections in place that give it more stability.
You can lower your DTI by paying off any consumer debt like credit card debt, increasing your income, or putting up a higher down payment to lower your projected mortgage payment.
How to Make Both Mortgage and Student Loan Payments
If you already have a mortgage and are struggling to make minimum payments, Dixon recommends doing what Pecknold did in her early years of homeownership: getting serious about budgeting. Write down all your household expenses each month. Figure out where your money’s going, eliminate unnecessary spending, and free up some extra cash to put toward those payments.
You can also consider refinancing your mortgage to take advantage of historically low mortgage rates, Pecknold says. It’s a step she recently took, and it knocked $350 off her monthly mortgage payment.
When to prioritize paying off student loans
First things first, says Anthony O’Neal, personal finance guru and author of Destroy Your Student Loan Debt. He recommends saving at least $1,000 in emergency savings before getting aggressive on debts. When that’s done, then you can go into triage mode.
In terms of lesser evils, “a mortgage is a better debt than a student loan debt,” Dixon says. A house will appreciate over time, so you’ll likely make money on it, even with interest. Student loans? Not so much. That’s why, generally, it’s better to prioritize paying off your student loans first, Dixon notes.
The other consideration is interest—student loans typically have higher interest rates than mortgages, so they suck money out of your pocket faster. Though forgiveness programs do exist for federal student loans, chances are slim—according to 2019 data, 99% of applicants are denied. “I would not wait on that possibility,” O’Neal says.
Instead, he recommends attacking student loans from smallest to largest before getting aggressive on mortgage payments. It’s a strategy called “the debt snowball.” The theory: Getting those smaller wins under your belt keeps you motivated to stick to your budget, O’Neal explains.
Depending on your credit history, grads may also be able to refinance their student loan debt to a lower interest rate, lowering their monthly payments.
What about saving for retirement?
Like paying off student loans, saving for retirement should also come before paying off your mortgage, says O’Neal. That’s because retirement accounts have a huge return over the course of your lifetime—often more than real estate, he explains.
Dixon suggests this order of priorities: First, start contributing enough to your 401(k) to receive your employer’s match. Second, work on paying off student loans. Only after that should you start overachieving on your mortgage payment.
“That 401(k) match represents extra income,” she says. “You want to make sure you’re taking advantage of it.”
When to pay more toward your mortgage
If you’re currently paying mortgage insurance, you might have an argument for putting a little more money toward your house each month. That’s because once you have a certain percentage of equity in your home, you can drop the insurance (which protects the lender, not you.)
“If you’re already contributing enough to your 401(k) to be receiving 100% of your employer’s match [and have paid off your student loans], then it would be better to get that $100 a month off your mortgage than to, say, max out your annual 401(k) contribution,” Dixon says.
How to Take Advantage of Pandemic Student Loan Forbearance
Due to the coronavirus pandemic and the ensuing economic crisis, federal student loan payments have been suspended through the end of 2020. It can be tempting to siphon any extra cash toward your mortgage—or toward other spending—but Dixon offers caution.
“Keep that money on the sidelines. You can make a decision later about whether to pay off more of that principle before the interest starts accruing again, or to put it toward other financial goals.” The forbearance isn’t a free-for-all, Dixon says—it’s an opportunity.
Maybe you find yourself going into credit card debt whenever unexpected expenses arise. If so, this can be your chance to build up your emergency savings, Dixon recommends. If you’re committed to ridding yourself of student loans, then it’s a chance to get ahead.
With either option, she says, “Your future self will thank you.”
Disclaimer: The opinions expressed by the interview subjects are not necessarily those of Earnest.