You may have heard the term “good debt” and “bad debt”. Good debt is typically a mortgage payment, car loan, and student loans; loans that have a consistent monthly payment and help build credit. Bad debt is considered revolving credit cards or excessive loans with variable payments.
I often get asked if student loans will affect an individual’s chance to get a home loan or if it will affect the terms of the loan. Student loans do have a close relationship with your credit history and score and tuition loans can impact your score in several different ways. Like I mentioned before, having a fixed installment payment can improve your credit as long as you pay it on time. If you have a high balance on that credit line it can harm your debt to income ratio and of course, if you have missing or late payments, it will definitely harm your score and bring the number down.
Regardless of what type of debt you have out there, the amount of debt compared to your income will determine how much you can afford to borrow.
At the beginning of this year, Americans owed about $1.5 trillion on student loans. Nearly 45 million people in this country carry student loans on a monthly basis. To put that into of some perspective, we only carry $1 trillion in credit and department store cards; that’s a lot of student loan debt! But this, of course, begs the question, how will it affect your chances of getting a home loan? And, is this stopping you from buying?
Obviously, if you have a mountain of student loans where you are paying out hundreds of dollars a month, adding on a mortgage payment may be even more detrimental to your financial well-being, however, if your income can support it, having that student loan and a mortgage may be obtainable.
Additional Resource: Can I buy a home with little or no down payment?
Your FICO score is one of the prominent factors in determining risk for a borrower. Simply making prompt payments makes up 35% of that score. Late payments on student loans can drop this score by 60 to110 points.
But, on the flipside, having student loans may actually have a positive impact on your score because a healthy “credit mix” accounts for 10% of your score. A good mix is typically one with installment loans, revolving credit accounts, and any miscellaneous loans such as car payments or personal loans. If all of your debt is credit cards or revolving loans, a student loan can actually improve your credit mix and increase your score. One of the best ways to increase your score is by simply paying all of your bills on time, including utilities, car payments, and student loans.
Will Credit Utilization Affect Student Loans?
All this is great information but, recently, a new concern called “credit utilization” has been brought into the mix making up 30% of your FICO score. This new rule applies only to credit cards, so the goal is to try and stay under 30% of the actual limit of the card. For Instance, if your limit is $5000 and you are applying for a mortgage and you want the highest credit score, you would try to keep your card less than $1500 to keep your utilization higher and your score as well.
This only applies to revolving credit and not student loans. So these utilization rules may not even apply. However, if you increase the amount you owe by deferment or forbearance arrangements, it can greatly affect your credit score. This is why I suggest not deferring any student loans if you can possibly help it. They only add to your debt, increased your interest, and prolong the time it takes to pay off the debt.
Additional Resource: How to Increase Your FICO Score
Bottom line, a well-maintained student loan will usually have a positive effect on your credit score. As long as you have a good mix of credit with both installment loans and revolving debt, and you pay on time, your credit score should naturally increase, as long as you keep paying down those debts. As long as your debt to income ratio is under 45%, which means that all of your debt combined should not be more than 45% of your income. This is really the main number that many lenders and underwriters look for.
Ready to get started? Give me a call at any time and let’s discuss your opportunity to buy a home. Student loans should not stand in the way of home ownership as long as all the other numbers, income, and eligibility requirements are met.
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