Will student loan debt impact a mortgage application?
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UPDATED: Mar 6, 2013
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Student loan debts do impact a mortgage application but they don’t automatically bar applicants from obtaining a mortgage.
Rather, there are varying factors which impact whether or not college-related debt will inhibit a borrower’s chance of owning a home.
Chris Birk, director of content development and executive editor of Veterans United Network, told loans.org that debt in and of itself is not always an issue.
When potential borrowers have a positive history of repaying student loans and other forms of lending, it shows lenders that he or she is a responsible borrower.
On the other hand, a borrower with a poor history of student loan repayment may raise some questions from mortgage lenders.
Student loan debts can positively or negatively impact a mortgage application based on the amount of debt owed, monthly income and how that debt has been managed.
Types of Debt Owed
Credit scores show debt in two different ways: installment loans and revolving loans.
Student loans, mortgage loans, and auto loans, which require a fixed monthly payment, are installment loans.
Conversely, credit cards are revolving loans because the borrower can decide what they want to repay each month: the minimum payment, the maximum payment, or some denomination in between.
Jordan Roth, senior branch manager for GFI Mortgage Bankers, said if there is too much student debt from undergraduate or graduate school, it could affect a borrower’s credit score and therefore lead to unfavorable mortgage lending.
But credit scores aren’t the only factor at play.
The amount of student loan debt impacts the borrower’s current debt-to-income ratio, which is a huge consideration by mortgage lenders.
Birk said this ratio is a significant factor in a mortgage loan application. He continued stating that the ratio is based on a numbers game.
Borrowers will likely need to “plug-and-play” to find out what their lenders will approve, Birk said. Although a borrower might initially want sufficient funds for a $250,000 home, their credit may only allow for a $225,000 home. If that’s the case, borrowers need to either be content with settling for a lower-priced property, or be prepared to wait until they can qualify for the home they want.
Beyond a debt-to-income ratio, lenders review the types of debt a borrower has, including bad or derogatory debts, such as tax liens, judgments, and collections.
“Many lenders will have a cap on the amount of derogatory income a prospective borrower can have,” Birk said. “No matter how much money you make, if you exceed that cap, securing a home loan will be difficult, if not impossible.”
While large levels of installment debt can be perceived as positive, Birk said income and assets play a key role in a mortgage application. In this regard, a borrower’s employment situation is critical.
“Lenders are looking for stable, reliable income that’s likely to continue,” he said. “Lenders want to see continuity and longevity if possible.”
Birk said the employment gold standard is staying at a job for over two years. Even though each borrower cannot provide this employment stability, it is something lenders will examine closely.
But younger borrowers are not alone.
The student debt dilemma can impact older generations that have taken on their own student loans for personal continuing education or for securing money for their family members. For co-signed loans, lenders will treat the debt as if it is the borrower’s own obligation which will be added to the applicant’s debt-to-income ratio.
Yet there is a silver lining.
“Lenders can essentially dismiss that co-signed student loan debt if you can show at least 12 months of on-time payments from the co-obligated child or that the student loan is deferred for at least 12 months,” Birk said.
How Debt is Managed
The final way to ensure a mortgage application is approved is to remain up-to-date on all debt repayments. Delinquent payment or going into default is a main cause for a failed application.
Roth said any missed or late payment will affect the borrowers’ credit scores. This low credit score shows lenders that a borrower is unfit to repay their debts, however small or large.
“As a student loan is considered an installment payment, a late payment would have more weight on your credit report than revolving debt associated with a credit card,” Roth said to loans.org.
The ability to repay should be a borrower’s main concern when applying for a mortgage loan. Birk said applying for a mortgage loan with student debt depends on a person’s unique situation.
After factoring for stable employment and a reasonable debt-to-income ratio, prospective borrowers should remember to balance their future debts.
“It’s important to step back and do some cold calculations. Be realistic about what you can afford,” Birk said. “Neither of these is something you want to default on at any point in your life.”