Buying a home has gotten increasingly difficult for many Americans.
With mortgage rates and house prices on the way up, home ownership may seem out of reach. These challenges hit student loan borrowers especially hard.
If there is good news in this situation, it is that not all hope is lost. The borrowers who understand how their student loans impact mortgage applications can tweak their repayment strategy to increase their purchasing power.
Student Loans, Interest Rates, Inflation, and the Most Important Number for Getting a Mortgage
I find that student loan borrowers often overestimate the importance of credit scores for mortgage applications.
While your credit score is an essential element to qualifying for a mortgage, it isn’t the most important one. The most critical number in the mortgage approval process is your Debt-to-Income Ratio or DTI.
When lenders look at your DTI, they look at home much you have to spend each month on your existing debts and your potential house payment. Then, they compare it to how much you earn each month. If the lender decides your salary isn’t sufficient to handle your current bills and the mortgage you want, you won’t be approved for the loan.
The changing economic climate hurts all mortgage applications. Higher interest rates and higher home prices mean larger mortgage payments for all homes.
Things hit student loan borrowers especially hard because these same factors cause havoc on their student debt in several different ways.
Monthly Student Loan Payment Changes
Borrowers with variable-rate student loans are hit hardest by the connection between inflation, rising interest rates, and student loans.
As interest rates increase to combat inflation, variable-rate student loan interest rates also increase. Higher interest rates mean higher monthly student loan bills. Student loan lenders report the higher monthly bills to the credit agencies.
When a mortgage lender looks at your monthly debts for DTI calculation, this higher monthly bill reduces your chances for approval and the size of the mortgage you can get approved.
Sherpa Tip: Many borrowers can lock in a fixed-rate loan to prevent variable-rate student loan increases. The options vary based on your loan type, and don’t work for everyone. However, many borrowers can lock in a fixed-rate loan to prevent increasing interest rates from hurting their approval chances.
Federal Payment Formulas are Slow to Respond to Inflation
Each month the cost of gas, groceries, and rent increases. Inflation hurts because your paycheck doesn’t go as far as it once did.
In theory, federal student loan payments are designed to stay affordable for borrowers. If you enroll in an IDR plan, your monthly payment is calculated based on your discretionary income.
Sadly, one of the problems with IDR calculations is that they respond slowly to inflation. The IDR formula for discretionary income is updated once a year. During times of heavy inflation, things can change quickly in six months.
For borrowers, this dynamic means that as their budget tightens, the IDR payment consumes a larger portion of their actual discretionary income. This makes it harder to save for a down payment and to eliminate other debts.
Making Sure Student Loans Don’t Wreck Mortgage Applications
The economic climate makes it harder to buy a house and makes student loans even more devastating.
Things have undoubtedly gotten harder, but that doesn’t mean student loan borrowers can’t become homeowners.