If you have been out of college for a few years or more, you may be considering buying a home. But if you still have student debt, you might pause before you submit that mortgage application.
Should you always repay your student loans before you take on a home loan? Or can you go ahead and buy a home with student loan debt? Financial experts will tell you that it depends. Every situation is different. If you can afford the home payment comfortably and can still put money away, it may make sense to buy a home. But again, it depends upon the situation.
Here are some good reasons to not worry about paying off your student debt before you buy your first home.
Your DTI Is OK
If you have a front end debt to income ratio that is below 28%, that is a solid sign that you may be able to afford a mortgage when you are still paying student loans. The front end ratio is your total mortgage payment, including taxes, interest, insurance, PMI, principal, etc., compared to your gross monthly income.
You Saved a Down Payment
Have you been able to pay down your student loans, and also have been able to save 20% or more for a down payment? Then this is another good indicator that you can afford a mortgage. When you save at least 20% for a down payment, you can often qualify for the best interest rates, depending upon your credit. You also are taking out a smaller home loan that gives you a lower monthly payment.
You Can Get More for Your Dollar
When you buy a home, you are building equity in a property, which is a key factor to consider. When you are renting, you are not building equity in the home in which you are living. In some markets (but not all!), renting costs more than buying. Depending upon the cost of real estate in your city, you may be able to buy a larger and better home than you can get with the same amount of monthly rent payment.
You Have a Low Rate on Your Student Loans
No one likes student loans, but they usually have lower interest rates than credit cards and car loans. Student loan interest rates are usually well under 10%, and they have a long repayment period. They also are unsecured debt, which means that you are not risking any property by not paying them, although doing so will damage your credit, of course.
What are some of the situations where you SHOULD pay off your student loans before you buy a home? Consider:
DTI Is Too High
The lender will look at your debt to income ratio to determine how much of a loan and payment you can afford. Generally, they want to see a front end ratio no higher than 28% and a back end ratio of no more than 36%. A few lenders may allow a back-end ratio of 43%, but that does not mean you should do it.
If you have a DTI that is 30% or more, you may want to not buy a home until you pay off more debt or get a higher salary in your job.
Your Down Payment Is Low
You don’t need a 20% down payment to buy a home usually. There are loans available with 3% or 5% down payments. The LA Times reports that most first time home buyers put down 20%, especially first time buyers.
But if you do not put down 20%, you will pay for expensive private mortgage insurance each month. You also will have a higher loan amount and a higher payment. It could be a bad idea to buy a home with less than 20% down if home appreciation in the area is only 2-4% per year. This would make it not as good of a financial investment.
Personal Financial Situation
How much do you have in savings for an emergency or if there is an expensive repair needed on the house? If you do not have a lot saved, you probably want to pay off debt before buying.
You Don’t Know Where You Will Live in 10 Years
If you are not sure that you will be living in that home in five or 10 years, you may pause on buying a home and keep paying off debt. Usually it takes time to sell a home – up to a year in the worst cases – so if you think you will need to move in a few years, you might wait.
The Bottom Line
Having a student loan does not always mean that you should not buy your first home. There really is not answer that is always right for every person. You should consider all of the above factors for paying off or not paying off your student loans before buying a home before you make a firm decision.