Millions of American Millennials are dealing with significant student loan debt, but they are also eager to buy homes and start their adult lives.
According to the Project on Student Loan Debt, about seven in 10 college seniors who graduated from public and private nonprofit colleges in 2015 had student loan debt, averaging $30,100. In some states, the average student loan debt was more than $30,000.
Yet many experts expect Millennials to enter the real estate market this year by purchasing their first homes. 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.
Millennials with student loans may worry their monthly payments are too high obtain a mortgage. However, 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.