You've earned your degree, nabbed your first job and are now ready to buy your starter home. But there's one problem: You're saddled with tens of thousands of dollars of student-loan debt. Will any lender approve you for a mortgage when you face that much debt?
Sure. If you can prove that you are financially stable enough to afford both your mortgage payment and your other debt payments.
Mortgage lenders don't treat student-loan debt any differently than they do the rest of your debts. In general, lenders want your total monthly debts - including student-loan payments and your estimated monthly mortgage payments - to equal no more than 43 percent of your gross monthly income, your income before taxes are taken out.
"Everyone needs to fall in line with that," said Chris Copley, regional sales manager in the Mount Laurel, New Jersey, office of TD Bank. "There is no other magic formula. After what happened with the economy in 2007, 2008 and 2009, the world of stated incomes and no-doc loans is a thing of the past. Borrowers now have to prove their incomes and debts if they want to qualify for a mortgage."
A heavy burden
Lenders might not view student-loan debt as being any different than an auto loan or credit-card debt. But this type of debt is certainly causing financial woes for college graduates. Edvisors, a group of Web sites giving advice to students on how to pay for college, found that the average college graduate in 2015 will leave college with more than $35,000 worth of student-loan debt.
That's the highest this figure has ever been. And many graduates are leaving school with far more than $35,000 to pay back.
Large student-loan bills coupled with relatively low-paying entry-level jobs might leave some graduates with debt-to-income ratios that are out of whack. These graduates might face monthly debt levels that consume far more than 43 percent of their gross monthly income. The vast majority of lenders won't provide these graduates with mortgage dollars. And if they do, they'll certainly charge them high interest rates.
Tilting the balance
The obvious way for borrowers to fix a debt-to-income ratio is to either increase their gross monthly income, reduce their monthly debt levels or both.
Say your total monthly debts, including your student loan payments, come out to $2,500 and your gross monthly income stands at $5,000. Your debt-to-income ratio is 50 percent. Lenders would consider that too high. But say you manage to reduce your total monthly debt to $2,000 - maybe by paying off some credit-card debt or selling your car and buying a used vehicle that doesn't require an auto loan - your debt-to-income ratio will drop to 40 percent, much better in the eyes of lenders.
It might not be possible for some recent college graduates to pay down debts or boost their incomes enough to improve their debt-to-income ratios. Graduates could reduce their monthly debt level, though, by choosing a less expensive house that comes with a smaller price tag and lower monthly mortgage payment. That would immediately lower a potential borrower's debt and debt-to-income ratio.
"Sometimes you have to be patient," Copley said. "You need to take the time to pay off some of your student-loan debt. Or you have to buy a house that is less expensive. You might not be able to get your dream house right out of the gate."
Will consolidating help?
Jason van den Brand, chief executive officer of San Francisco-based Lenda, an online mortgage-refinance platform, recommends that college graduates consolidate their student loans. Graduates might be paying off as many as six student loans at one time. By consolidating these separate loans into one, graduates might be able to nab a lower overall interest rate on their student-loan debt, van den Brand said.
A lower interest rate will result in a lower monthly payment. That could lower a graduate's debt-to-income ratio enough to make a mortgage a possibility.
"That should be the very first thing you do after graduating from college," van den Brand said. "Start looking to consolidate those loans into one with the lowest possible interest rate you can find. Shop around for that lower rate. It could make a real difference."
Graduates should also come up with as large a down payment as possible, van den Brand said. Say a couple graduates want to buy a home that costs $300,000, he said. A down payment of 20 percent would come out to $60,000. If they can can come up with that money, they'd reduce their total mortgage to $240,000. A mortgage of that size would come with lower monthly payments than would one of $300,000. The payments might even be low enough to leave them with a solid debt-to-income ratio, even if they are paying back tens of thousands of dollars of student-loan debt.
Saving that much money isn't easy, but it is possible, as long as college graduates are willing to wait before buying their first home after graduating, van den Brand said.
"You might have to wait three or five years, but do it," van den Brand said. "You are so much better off buying a house with a larger down payment. Your monthly payment will be so much lower than if you just went with a 3 percent down payment to get into a government-insured mortgage."
Pay your bills
One last step? Pay your bills on time, including those student-loan payments. If you do this -and if you keep low balances on your credit cards - you will end up with a strong credit score.
That's important. The better your credit score, the lower your interest rate on a mortgage. When your interest rate is lower, so is your monthly payment. If your credit score is high, then, that lower monthly mortgage payment might leave you with a stronger debt-to-income ratio.
"You have to be financially responsible if you want to buy a house, whether you have student-loan debt or not," van den Brand. "If you keep your credit scores high, you'll give yourself more of a chance to qualify for a mortgage loan even if you do have student-loan debt."