Lenders put a lot of focus on your debt ratio. They want to know that you can afford the new mortgage beyond a reasonable doubt. Without proper proof, you run the risk of default, which can hurt a lender. Even if you’ve kept yourself out of credit card debt, you may still have another debt that can damage your chances of loan approval – student loans.
This isn’t to say that anyone with student loans cannot get a mortgage, because they can. What it depends on is your debt ratio, not only now, but in the future too. This means that even if you have deferred student loans, it will still affect your loan approval.
Keep reading to see what you can expect if you have student loans.
Using Your Student Loan Payment
If you have student loan debt that you currently pay, chances are your credit report shows the same payment that you make each month. This is what lenders will use to determine your debt ratio. If you aren’t making payments right now, though, things can get a little trickier. Lenders can’t just overlook the impending debt, because you’ll have to pay it someday. Instead, they must include some type of payment when they determine your debt ratio.
Figuring Out Your Payment
If you aren’t making payments right now, you’ll need to know what payment lenders will use to qualify you for a loan. What you should know is that the more proof that you provide of your upcoming payment, the better your chances of approval.
If a lender can’t find sufficient proof of your upcoming payment, they must use 1% of the outstanding balance. That could amount to a very large payment that would probably throw your debt ratio way off where it needs to be. On a $20,000 loan, you’d have a payment of $2,000 used in the calculation. Unless you make a lot of money every month, this wouldn’t leave much room for a new mortgage payment.
If you are in a formal deferment plan, show the lender the paperwork for this plan. It should say somewhere in there how much you are expected to pay once the deferment period ends. If your paperwork doesn’t specify a payment, you can contact your servicing lender to get official proof of the upcoming payment. If you are in a loan forgiveness plan, make sure you have proper proof of when the balance will get forgiven, so the lender can take that into consideration as well.
If you don’t have paperwork showing an exact payment, but you have proof that the term will be 20 years when you come out of deferment, the lender can do the calculations. They will determine your payment based on the interest rate you have and a 20-year term. This usually comes out much better than the 1% of the balance calculation.
How High can Your Debts Be?
Just how much debt you can have compared to your gross monthly income depends on the chosen loan program. For instance, conforming loans have the toughest requirements. You must have a total debt ratio less than or equal to 36% to qualify. You may find some lenders willing to go a little higher than that if you have compensating factors, though.
FHA and USDA loans allow a maximum DTI of 41% on the back-end and VA loans allow as much as a 43% back-end ratio. The back-end ratio is the total of all of your debts including the new mortgage. It includes things like your minimum credit card payments, installment loan payments, student loan payments, and personal loan payments.
The lower you can get your back-end DTI, the better your chances of loan approval become. But, as we said above, you may be able to get by with a higher DTI if you have compensating factors.
What are Compensating Factors?
Lenders look at the big picture when determining if you qualify for a loan. They don’t look just at your credit score or just at your debt ratio and either approve or deny your loan request. Instead, they look at everything. For example, if you have a high credit score, but also have a high DTI, they still may approve you because of your high credit score. If you had a low credit score and a high DTI, your chances of approval are much smaller.
Aside from credit scores and DTIs, lenders also look at your stability in other areas of your life. Take employment for example. If you have a steady employment history, lenders may use that as a compensating factor for a slightly elevated DTI. If you have steadily increasing income, that could also serve as a compensating factor as it proves that you continually improve your income, which lowers your DTI.
Of course, lenders look at your credit score and DTI the most, but they aren’t the only deciding factors. Make all aspects of your loan application look as attractive as possible in order to get the loan approval that you need. If you do have student loans, make sure that you get as much proof as possible of their impending payment so that you can get qualified for the mortgage you need.