Millennials are shouldering heavy student loan burdens at the exact moment in life when they want to step up to the adult table by settling down and buying a home. But because home buying requires that most people take on even more debt—in the form of a mortgage—many would-be homeowners hesitate at the threshold of this big life decision.
If you’re carrying student loan debt, should you take on housing debt, too? The answer, as with most big financial decisions, is this: It depends.
Considering Home Ownership
On the one hand, if your credit is decent, you know you’re planning to stay in a given region for at least three to five years, your income keeps growing, and the economy is strong, there’s a case for examining homeownership. However, before you go shopping, it pays to do some homework about how mortgage borrowing works—and how your student loan debt will influence your borrowing power.
Young adults are buying homes at a lower rate now than yesteryear: The homeownership rate among 25-34 year olds dropped by 13% between 1989 and 2016, according to research from consulting firm Young Invincibles. However, buying remains a goal for many young adults—and even if they are postponing it while they build earning momentum and chip away at debt, it’s not impossible.
Here’s a look at some of the financial considerations you’ll need to make if debating whether you can afford (or should pursue) a home purchase while also your managing student loan debt.
How Lenders Look at Your Debt
First, the good news: Mortgage lenders know that debt is a fact of consumer life and expect that you may carry debt. Whether you carry debt for a student loan, a car, or credit cards, lenders expect that borrowers are managing a varied mix of expenses. Lenders look at two ratios when evaluating whether and how much to let you borrow, sometimes known as “front-end” and “back-end” ratios.
First off, on the “front end,” lenders don’t want to see you pay more than 28% of your total gross (pre-tax) income for housing expenses—including your mortgage payment (consisting of principal plus interest), property taxes, and insurance. This figure is sometimes called “PITI” and is an acronym that stands for principal, interest, taxes, and insurance. So if you’re earning $5500 a month, they don’t want to see you pay more than $1540 for all those expenses combined. (And even if you don’t buy, it’s good to apply this principle to how much you pay for rent—as preparation for budgeting to buy.)
Second of all—and this is where things get interesting—lenders don’t want your housing payment combined with other debts (like credit cards or student loans) to exceed a certain proportion of your gross income. Depending on the lending environment, loan type, your credit, and your down payment, what constitutes an acceptable “back end” figure is typically 36% but can stretch as high as 50% of gross income, even on FHA loans to new borrowers.
Using the 50% max, if you’re earning $5500 a month then lenders don’t want your housing and other expenses to exceed $2750. If your housing payment is $1540, and you have a $650 student loan payment, a $100 credit card payment, and a $250 car payment, your total expenses are $2540, or 46% of gross income. And that’s an acceptable ratio, in many cases. For lenders, it doesn’t matter what sort of debt you’re managing—just the total figure. (Of course, credit card debt carries high interest and more risk so if your debt is entirely credit card-based that may negatively influence your credit score—but the point is that lenders accept that borrowers will have any number of debt types.)
How Financial Advisors Consider Your Debt
Just because it’s possible to borrow to buy a home with your particular financial profile, does it mean you should? Financial planners and investment advisors may have a different point of view about whether you should take on mortgage debt or, if not that, more conservative views on how much it makes sense to borrow for housing or what other prerequisites they’d want to see before you take the leap.
Buying a home takes a large bite out of any consumer’s disposable income—meaning that those who overbuy may be doing so at the expense of investing for retirement. Even if a home’s value rises over time and allows an owner to build equity, it’s debatable if those returns can outpace securities market investing. On the flip side, though, if your earnings rise and home payments remain level then your housing costs (and how large a portion of income your student loan represents) will both shrink as a proportion of earnings—leaving you room to invest.
While mortgage borrowers may carry whopping levels of student loan debt they won’t be able to pay off quickly, some reports indicate that it’s credit card debt rather than student loan which hinders buying. While it’s important to stay on top of student loan payments, it may be more important to pay down credit card balances or pursue strategies to lower credit card interest rates so card repayment approaches take effect faster.
While a five-figure student loan balance may be hard to erase prior to your pursuing a mortgage loan, it’s easier–and generally financially wiser–to pay off high-interest consumer debt so student loan payments don’t throw off the ratios mortgage lenders like to see. Nixing credit card debt can not only leave consumers with better mortgage borrowing prospects (try the calculators above!) but also provide investable money that can grow in the stock market or in emergency savings.
Understand Your Options
Debt-strapped would-be buyers may find that while they can get a mortgage while carrying student loan debt, they may not be able to borrow as much as they want or they feel they need in order to live in their current market. For this reason, many Millennials who live and work in dense metro areas are skipping urban housing options and buying in the suburbs where prices are cheaper.
Knowing that buyers have student loans, both housing community developer Lennar and lending organization Fannie Mae have designed loan products that help borrowers manage student loans and a mortgage concurrently.
But ultimately, finding ways to bring debt levels down to satisfy the ratios lenders like to see may be the fastest ways to get your hands on a set of keys—both to a home you own, and to a solid financial future. Whether that means nixing consumer or auto debt so student loan debt is the only debt you carry when applying for a mortgage or that you refinance and consolidate student loan debt so payments comprise a manageable portion of income, it’s important to understand how your student loans color–but don’t necessarily preclude–the home buying process.