First-time home buyers have always been critical to the health of the housing market. Today, first-timers make up 29% of all home buyers, far below their peak of 50% in 2009, according to the National Association of Realtors. Student loan debt is one of the reasons for the decline. Since 2008, all major categories of household debt have decreased with the exception of student loans. Here’s a closer look at how student loan debt is hurting first-time buyers.
One of the key criteria that borrowers must pass before getting a home loan is debt-to-income ratio. This ratio measures the amount of debt one has relative to their income. Mortgage lenders need to know if borrowers are able to take on additional debt without overextending themselves. Even if a student lands a well-paying job right out of college, it most often takes ten years to pay off student loans. Granted, students in their early twenties may not desire to jump into home ownership immediately out of school, but clearly the length of time it takes to pay off student debt can intersect with the timing when home ownership does become a serious goal.
Another test that a buyer must pass is the credit score. Lenders require scores in the high 500s to low 600s to apply for a mortgage, depending on the type of loan. Unfortunately, when people can’t afford all their bills, student loans are one of the first payments they let slide. Delinquency rates on student loans have doubled to 12% over the past decade. Missing loan payments hits one’s credit score very harshly. According to lenders, it can cripple one’s ability to get a mortgage for up to seven years. There are federal student loans that allow for deferment or forbearance in times of financial hardship, however most private loans do not.
Saving for a Down Payment
The other critical piece for first-time buyers is the ability to save the typical 20% down payment required for a standard conventional loan. With student loan payments owed on top of everyday living expenses and other debt, it can be tough for buyers to set money aside. Certainly there are lending programs that require far less than 20% down, however these loans are likely to require PMI (private mortgage insurance) in addition to interest for the loan. While PMI helps people get mortgages, it slows down one’s ability to build equity in their home.
If people with high student debt have home ownership on their goals list, there are further steps they can take. Just as home owners can refinance a house, borrowers can refinance student loans. Borrowers may find a lower interest rate and lower monthly payments, freeing up cash for savings. Also, federal student loans offer income-based repayment plans to those who qualify. And on a final note, if a borrower’s income allows, it’s worthwhile to pay off more than the monthly payment or even make additional payments each year on student loans. Even an extra $25-50 more per month can lower interest by thousands of dollars for the full-term of the loan.
Real Estate Term of the Week
Income-Based Repayment: A federal student loan repayment program that adjusts the amount you owe each month based on your income and family size. With an IBR plan, your payment amount is capped at a certain percentage of your discretionary income or the amount you would pay under the 10-year Standard Repayment Plan. The percentage rate depends on when you took out the loan and if you had existing federal student loans.