Vol. 42 No. 6
Heather Jarvis is an attorney and student loan educator and is the founder of askheatherjarvis.com.
Getting a mortgage isn’t as simple as it once was. This article provides tips for student loan borrowers considering mortgages. Begin by making sure that everything on your credit report is accurate because it takes time to correct any mistakes. Three months should be sufficient time to detect and correct mistakes.
Save for a Down Payment
Different mortgage loan programs require different down payment amounts, usually ranging from five to 20 percent of the house’s purchase price. Your down payment amount affects the amount you borrow, your interest rate, and whether you’ll be required to pay for mortgage insurance. If you put down less than 20 percent your lender will probably require you to pay for mortgage insurance, increasing your monthly payments without increasing your equity. If you aren’t in a position to put 20 percent down, you may want to consider a Federal Housing Authority (FHA) loan. Borrowers with FHA loans pay for government guaranteed mortgage insurance, which enables lenders to offer FHA loans with flexible qualification requirements and better terms.
Evaluate the strength of your FICO credit score
Mortgage lenders typically look at FICO credit scores when considering a mortgage application. In October 2013, mortgage applicants who were approved for conventional mortgages had FICO scores averaging 758 while those who were rejected had FICO scores averaging 711 (Ellie Mae Origination Monthly Insight Report, October 2013). A year ago, only 16 percent of all approved applicants had a credit score of less than 700 but now the figure is 28 percent. This indicates that lending standards have loosened somewhat.
Calculate your Debt-to-Income Ratios to determine how much you can borrow.
Lenders use two debt-to-income ratios to determine how much you can borrow: “front-end ratio” and “back-end ratio.’ Front-end ratio is your housing expense ratio including your projected mortgage payment of principal and interest, taxes, and insurance. Back-end ratio is your total monthly debt payments including your projected mortgage payment plus other debt payments like car loan, credit card, and student loan payments.
Generally, front-end ratio should not exceed 28 percent of your gross monthly income and back-end ratio should not exceed 36 percent of your gross monthly income.
To calculate your debt-to-income ratios:
Your annual salary x 0.28 / 12 (months) = front-end ratio
Your annual salary x 0.36 / 12 (months) = back-end ratio
Sometimes lenders will allow higher ratios if you have a high credit score, a big down payment, or a lot of cash in the bank. Government mortgage programs, like FHA and VA mortgages, may also allow higher ratios.
If you can prove that your student loans will be deferred for at least a year after closing on the house, some lenders will not count student loans in your ratios. But if you are making payments or will be soon, lenders generally assume a monthly student loan payment of one and a half to five percent of your total student loan balance. That may overestimate your monthly student loan obligation, particularly if you are making income-based student loan payments. Demonstrate your actual monthly student loan payment to your mortgage lender by requesting a loan verification letter from your student loan servicing company. The letter will set out your loan details, including your actual or estimated monthly payment amounts.