Approximately 37 million Americans have student loan debt, according to Federal Reserve data. That’s roughly one out of eight of your friends, family members, and neighbors, who are saddled with an average of more than $27,000 in student loans. Maybe, you’re even one of them.
If you are, your student loans will obviously affect your ability to borrow money to finance a home purchase, like any other debt, but even if you don’t have student loan debt, you may find yourself impacted by those who do. As more and more people have student loan debt that affects their ability to borrow, there will be fewer buyers able to purchase your home.
As the total outstanding student loan debt approaches $1.3 trillion in the United States, here’s what you need to know.
When you apply for a home loan, lenders calculate your debt-to income ratio by adding up all of your monthly debt payments, including your expected mortgage, and dividing the total by your gross monthly income (the amount you earn before taxes and other deductions). To qualify for a conventional loan, the result should be 43 percent or less.
That may not seem difficult until you start putting numbers on paper. Let’s say you’re a recent college graduate earning $48,127 annually, the average salary for the class of 2015 according to the National Association of Colleges and Employers. Your gross monthly income would be $4,010. You have a car payment of $300 and a credit card payment of $200 plus $30,000 in student loans. Assuming this is an unsubsidized Stafford loan, you can add a monthly payment of $312.
Now factor in your home mortgage. Let’s say you’re applying for a home loan for $200,000 with a monthly payment of $1,013. Your total monthly payments (including the car, credit card, student loan, and estimated mortgage payment) would be $1,825, putting your debt-to-income ratio at 45 percent, well over the 43 percent threshold.
In this scenario, you probably won’t qualify for that loan amount, but with some adjustments, you might still be able to buy a house. You could:
- Put more money down or find a less expensive house. The smaller mortgage payment will lower your debt-to-income ratio. Another way to reduce your debt-to-income ratio is to pay off other debt such as your car or credit card.
- Switch from a standard to a graduated payment plan, which starts low and gradually gets higher. **Only use this option if you expect your salary to increase in the next few years, and of course check on this with your lender.
- Consolidate your student loans. This can sometimes reduce your monthly payment and help you qualify for a home loan.
- Defer your student loans or get a forbearance. Although this option eliminates the monthly payment, the debt continues to grow. If you get to a point where you earn more than you initially borrowed, it can negatively impact your FICO score.
- Use FHA financing versus conventional financing. FHA financing allows a slightly higher debt-to-income ratio of 45 percent.
Experts disagree on how much of an impact the student loan crisis will have on the housing market, but analysis of the 2014 housing market by John Burns Real Estate Consulting estimated that student loan debt caused an 8 percent decline in home purchases among buyers ages 20 to 39.
Plus, even the college graduates who can afford houses may be qualifying for less. The same is true for people in their 30s who may still be struggling to pay off their student loans or older Americans who returned to college to further their career.
There is good news, though. First, the Southwest, including Arizona, is less affected by the student loan crisis, with those who have student loans owing less than the national average. Second, most home buyers who have recently graduated from college, those who would theoretically have the most student loan debt, can’t afford a Scottsdale home, where the average price pushes $400,000- therefore, you shouldn’t worry too much about it affecting our market in the Northeast Valley.
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