Sometimes people are surprised that we bought a house even though we have student loans. And that makes sense. Student loan debt can completely cripple your finances, including (maybe especially?) crushing your chances of buying a house. In fact, CNBC recently reported that 83% of people ages 22-35 with student loan debt who haven’t bought a house yet blame their student loans. That’s a pretty big deal. I really can’t tell you whether you should (or shouldn’t) buy a house if you have student loans, but as someone who has been there, I can give you all of the things I considered in making my decision to buy a house despite those pesky student loans.
What you should know when you’re deciding whether to buy a house if you have student loans
(1) Know how your student loan payments impact lending:
Debt to income ratio
When a lender looks at your mortgage application, they are going to consider how much debt you have compared to your income. This is commonly called your “debt-to-income ratio.” So, for example, if you have $400,000 in student loans and you haven’t started working yet, in other words, your income is $0, that is obviously something the lender is going to consider in deciding whether he should loan you a bunch of money for a house.
A debt-to-income ratio that lenders like is usually under 36%. Meaning, the your debt payments each month take up less than 36% of your income each month. So if your monthly student loan payment puts you above that limit does that mean you’ll never get a mortgage? Not necessarily. It just means you need a different strategy. You can refinance with a private lender for a longer term AND lower your interest rate, if your loans are federal you can switch to an income driven repayment plan to lower your monthly payments (even though you could still make aggressive payments on an income driven plan). With either of these options you run the risk of paying more for your student loans (as interest will be accruing) so do make sure to run the numbers for yourself to see if its worth it the potentially added costs. After you have your mortgage, you can change your plan and make more aggressive payments towards your student loans again.
Payment history accounts for 1/3 of your credit score, and credit is definitely something a bank is going to consider in deciding whether to take the risk of lending you money for a house. Thus, it’s key to pay your student loans ON TIME every time. An easy way to do that is to set up auto draft from your student loan lender. Almost all student loan servicers offer this option and many of them will give you a discounted interest rate for doing so.
Savings and upfront costs.
One very important thing you should consider when you are deciding whether to buy a house if you have student loans is whether you can save enough money to buy a house while continuing to make your student loan payments. It’s probably not a shock to you that upfront costs of buying a house aren’t cheap. Depending on the kind of mortgage you plan to get, you will need anywhere between 0-20% of the cost of the home for a down payment. In addition, you may need some cash for closing costs. On top of that, you’ll most likely need a little cushion for moving costs and getting into your home. Then of course, there are always unexpected costs that you’ll want to be prepared for.
And while you will certainly need some savings to get into a house, there are a number of ways you can minimize the amount of money you’ll need upfront. For example, there are all kinds of mortgages available to alleviate some of the burden of your down payment. We got into our home using a physician’s loan since Danny is a dentist, which meant that we didn’t have to make a down payment at all. There are similar mortgages for lawyers and other professions that are most definitely worth looking into.
Another way to minimize upfront costs is to negotiate closing costs if you can. Have the seller be responsible for closing costs. Also be sure to shop around for the best/least expensive home owner’s insurance you can find.
(2) Know how much house you can afford.
Probably the most important thing you can consider to decide whether you should buy a house if you have student loans is how much house you can afford (if at all) while still making your student loan (and other debt) payments. This is KEY to buying a house when you have student loans. You most likely are not going to be able to buy your dream home while you are still paying off debt, but that doesn’t mean that you can’t get into a home at all. Make sure you have a solid grasp of what your income is versus your household expenses, including debt payments. I would personally recommend staying WELL under the 36% rule described above. A better rule of thumb is don’t buy a house that costs more than twice as much as your yearly salary. But that is not a commandment- you might be able to work something out to make a more expensive house work for you (for example– consider doing something like buying a duplex, living in one side and renting out the other). Don’t be afraid to be creative, just have a firm grasp of income versus expenses so you don’t get yourself in a bind.
We were on an income driven repayment plan when we were searching for a house. This freed up quite a bit of cash flow for us so that we could afford our initial payments and closing costs. It also helped when we were getting financing– all of our paperwork indicated that we only owed a couple hundred dollars per month towards our student loans. Of course we were making extra payments on top of the minimum, but having the paper work say that our minimum payment was low was key for us to get our financing and to keep our heads above water when we were first getting settled in.
[As an aside, after we were in our house for a while, we switched from an income driven repayment plan and refinanced our student loans with a private lender because again, we knew we could afford the payments and we wanted to cut our interest rates down.]
(3) Have an exit strategy.
If you decide to take the plunge and buy a house when you have student loan debt, you need to have an exit strategy, i.e., a plan to get out of the mortgage if you end up in a different position than you anticipated. This could be a variety of things– perhaps the location isn’t working for your commute to work, maybe you have a neighbor you don’t like, maybe you lose your job and are struggling to make payments, etc. What will you do if things go south or if you decide you no longer want the house? Is your house in a hot market where it will sell easily? Are you willing to rent out your home? Are you in a good rental market, and are you willing to be a landlord?
In our area, the cost of rent is fairly high in comparison to the cost of house ownership. Our monthly payment on our house is far less than what we would pay for a comparable place in rent. In addition, we currently live in a hot market that is close to down town, where houses sell pretty fast. Our house was not even close to twice our yearly income. We feel really comfortable being landlords and renting out our house (in fact, that was the main intention for buying our house in the first place, to get started with a little real estate investing. You can read more about that here). So buying a house made total sense to us. It might not make sense for you. You have to be really careful weighing out these factors in making your decision.
What about you? Would you buy a house if you have student loans? I’d love to hear from you!