Student loans can let people who would otherwise be unable to afford college get a degree. But they can also present an obstacle to achieving another element of the American dream -- homeownership.
Approximately 32% of millennials have put off purchasing their first home because of debt, primarily student debt, according to a 2016 Bank of America study. While the study found Gen X members also delay home buying because of debt, student debt is a particularly Millennial issue. In 2013, the average student loan amount was $7,000, according to the National Center for Education Statistics. That is 39% more than the $5,100 inflation-adjusted average in 2001.
This is an issue when it comes to buying a home, because lenders are generally reluctant to approve applicants whose monthly debt service payments top about 43% of income. Adding student loans to mortgage, auto loan and other debts often puts student borrowers too far above that ratio.
In fact, many have trouble keeping up with their student loans. The National Center for Education Statistics said nearly 14% of 4.7 million people who started repaying student loans in 2011 had defaulted by the end of 2013.
The debt-to-income hurdle makes many students despair of buying a home, according to Kathy Cummings, a first-time home buyer expert at Bank of America in Charlotte, North Carolina. "The perception is that it is absolutely a showstopper," Cummings says.
However, lenders say student debt need not preclude homeownership. "We're trying to dispel the attitude that you can't have student debt, you have to have a perfect credit score and you need 20% down," Cummings says.
Borrowers may also be able to lower student loan payments by requesting a deferment. This lets them temporarily postpone or reduce monthly payments. Borrowers have to qualify for deferment, but approval usually is not difficult, says Barry Coleman, senior director of student loan counseling at the National Foundation for Credit Counseling, a Washington, D.C., association of credit counseling firms.
Another option is to request a change to a graduated payment plan. This lets borrowers reduce payments for two years. After that, payments increase every two years. Graduated payments can work for a recent graduate working at a job likely to involve future raises. "If you feel your income is going to substantially increase over the years, graduated payment is something you might want to look at," Cummings said.
Consolidation loans are a third way to shrink the debt-to-income ratio. A borrower with several outstanding student loans can combine them into one. The new loan will use the average weighted interest rate of the existing loans, and the term can be extended to up to 30 years. Since student loans often must be paid in ten years, this can significantly reduce monthly payments.
Consolidation loans are offered by private lenders. Borrowers considering a private loan to consolidate federally-insured loans need to know they are giving up the ability to request deferments offered under the federal program, notes David Weliver, founder of Money Under 30, a personal finance education website for young adults in Portland, Maine. "The downside is if you ever want those federal benefits of stopping payments if you lose your job, you're not going to be able to do that if you refinance into a private loan," Weliver said.
Even if student borrowers can't or don't restructure student loans, they can improve their debt-to-income ratio by reducing other debts. And it may not be necessary to pay off other debts completely. Mortgages backed by the Federal Housing Administration and Veterans Administration let borrowers exclude payments on most installment loans with less than ten months to payoff. "If they can at least pay them off to where they're within 10 months of paying them off, that debt is not included," Coleman said.
Student loans present special problems for many would-be homeowners. While there are ways to deal with some issues, avoiding paying back the loans at all is not always possible, even in event of extreme financial duress. Federally-backed student loans are one of only a few debts that cannot be discharged through bankruptcy, notes Cummings.
College and homeownership remain part of successful life for many. But some would-be mortgagees also burdened by student debt may be wise to wait until those loans are paid off before taking on a mortgage. A mortgage is a big obligation that, like a student loan, can limit future financial options, notes Weliver. "Just because the bank will approve it," he says, "doesn't mean you should do it."