According to the Project on Student Loan Debt, about seven in 10 college seniors who graduated from public and private nonprofit colleges in 2013 had student loan debt, averaging $28,400. In some states, the average student loan debt was more than $30,000.
Yet in a study by loanDepot, one of the top 30 mortgage lenders in the United States, more than one-third of Millennials plan to purchase a home in the next five years. With all that student loan debt to pay off, how are they going to do it?
Perception vs. reality
There’s no doubt that student loan debt can pose a problem for Millennials who want to buy a home—it can skew their monthly debt-to-income ratio and make it difficult to qualify for a loan. However, the situation may be less dire than they think.
To determine your debt-to-income ratio, lenders look at the monthly cost you pay to service your debt, not your overall debt burden.
Many survey respondents believed that they needed to reduce their payments by more than $300 per month to qualify for a home. However, the loanDepot analysis found that a first-time homebuyer with student loan debt only needs to reduce his or her total monthly debt payments by between $150 and $300 to qualify for a home loan.
Thus, even small changes in the size of a loan applicant’s monthly debt payments can make a big difference in whether a loan gets approved.
Assuming your gross monthly income is $4,000 and your other monthly debt service—student loan, auto loan, and credit card payments—is $900, your DTI ratio is 23 percent. If you apply for a mortgage with a monthly payment of $1,000, your DTI ratio climbs to 48 percent.
With a DTI ratio of more than 43 percent, you may have a smaller chance of getting approved for a loan. However, if you can cut your monthly debt service by $300, your DTI ratio will drop to 40 percent, giving you a better chance for approval.
Tips for reducing your debt
To get an idea of where you stand, add up all the monthly payments you make and divide that number by your gross monthly income. If student debt is pushing you over the top, here are some tips to help you reduce your monthly debt load so that you can qualify.
1. Start early. If you wait until the last minute to reduce your debt load, you won’t have many options. Start a year before you plan to buy a home and create a plan that will bring your monthly debt load down to a level that will pass muster with a lender.
2. Pay off low balances. Review your credit accounts and pay off those with low balances. By doing so, you can quickly lower your monthly debt service.
3. Consolidate consumer credit. Shop around for a credit card with a low APR, even if it’s a temporary deal. Use it to pay off your expensive accounts.
4. Reduce your living expenses. The more money you save, the more money you can put down on your new home. Eat out less, take public transportation, and cut back on trips to the coffee shop.
5. Increase your income. Take a part-time job or do freelance work to augment your income. Use the proceeds to pay down debt.
6. Avoid new debt. Wait until after you have purchased your house to make large purchases on your credit card or buy a new car.
Student debt need not keep you from becoming a homeowner. Good planning and money management can help make the dream of homeownership a reality.
Steve Cook is executive vice president of Reecon Advisors and covers government and industry news for the Reecon Advisory Report. He is a member of the National Press Club, the Public Relations Society of America, and the National Association of Real Estate Editors, where he served as second vice president. Twice he has been named one of the 100 most influential people in real estate. In addition to serving as managing editor of the Report, Cook provides public relations consulting services to real estate companies, financial services companies, and trade associations, including some of the leading companies in online residential real estate.