If there is good news in this challenging situation, many borrowers can take simple steps to improve their application.

Picking the right student loan repayment plan isn’t just about keeping things affordable or qualifying for loan forgiveness. The right student loan repayment selection can turn a mortgage application rejection into an approval.

Debt-to-Income Ratios: The Reason Repayment Plan Selection is Critical

One of the most important figures on any mortgage application is the debt-to-income ratio.

The Debt-to-Income Ratio or DTI looks at a would-be borrower’s monthly income compared to their monthly debts. Many people mistakenly assume that this number is pretty much set in stone. Fortunately, student loan borrowers can improve their DTI without paying off a loan in full or getting a raise.

Because mortgage companies use credit reports to determine debts, the monthly bill reported by lenders and federal servicers is critical. Thus, picking the right repayment plan can make a massive difference in the DTI analysis.

Sherpa Thought: At the risk of repeating myself, borrowers must understand that monthly debts and income matter far more than total debt or yearly income.

In other words, a borrower with a $500 monthly bill for a $5,000 loan balance will get treated the same as a borrower with a $500 monthly bill for a $100,000 loan balance.

It might sound ridiculous, but mortgage companies follow strict standards and formulas when underwriting. The monthly payment is critical, and the interest rate and total balance don’t really matter.

The New SAVE Plan Makes it Easier to Buy a Home

The New SAVE plan is the most generous Income-Driven Repayment Plan currently available.

Borrowers get to keep a larger percentage of their income, and the discretionary-income calculation has been further tweaked in favor of borrowers.

For many, the result is a much more affordable monthly payment.

Thus, signing up for SAVE could mean a much lower monthly bill and improved odds of qualifying for a home loan. To estimate your monthly bill on SAVE, use this SAVE calculator.

What if I want to pay more each month so I don’t spend a ton of money on student loan interest? Some borrowers have avoided SAVE because they wish to pay off their debt quickly.

However, this approach is usually a mistake. Borrowers can pay extra toward their federal loans whenever they want. The monthly bill is the minimum monthly payment. There isn’t a penalty for paying extra to knock out the debt faster.

Changing IDR Payments and Mortgage Lender Nonsense

Historically, some mortgage lenders refused to accept monthly payments on IDR plans like SAVE. They reasoned that because the IDR payment could go up, it wasn’t a reliable number to use for DTI analysis.

Thankfully, common sense has mostly prevailed. Lenders now recognize that a monthly payment would only increase if the borrower earned more money.

However, it is worth noting that different banks and lenders may have unique rules and standards. The policies outlined in this article apply to most lenders, but your local bank or credit union might have a strange student loan policy. If that is the case, moving on to a more reasonable lender is often the easiest fix.

The Danger of Income-Driven Repayment Plans like SAVE

Even though most lenders will now accept IDR payments for DTI calculations, there is one circumstance where they revert back to the older and more harsh rules.

If you qualify for $0 per month student loan payments, many lenders will refuse to accept the $0 payment for DTI calculations. Instead, they will use .5% or 1% of the total loan balance. For example, a borrower with a $0 per month payment and a $50,000 student loan balance will get treated as though they have to pay $500 or $250 per month on their student loan.

For borrowers with sizeable federal student loan balances, qualifying for a $0 per month payment may tank a mortgage application.

Thus, if you are going to apply for a mortgage in the next year, the best repayment plan to select is the one with the lowest monthly payment, as long as it is above $0.

To see projected payments across all federal repayment plans, use the Department of Education Loan Simulator.

Plan Selection Alert: Some borrowers may find that the graduated or extended repayment plans offer the lowest monthly payment and best chances at a mortgage approval.

Because these older plans do not qualify for PSLF or IDR forgiveness, borrowers who use these plans for mortgage applications should switch back to their desired IDR plan as soon as the home closes.

Don’t switch back too early and have it mess up your closing. Running a credit check just before signing is common, and a new loan or new payment can cause issues.

Repayment Plan Selection for Private Loans

Private loans are notoriously more difficult than federal loans when it comes to repayment plan selection.

Income-driven repayment plans are not available, and borrowers have little say in their monthly bills.

A deferment or forbearance usually doesn’t help because mortgage lenders will use .5% or 1% of the loan balance for DTI calculations.

Despite these limitations, calling your private lender to ask about repayment plan options is often helpful. Switching from a 5-year repayment length to a 10-year repayment length would mean a significant drop in your monthly bill. Just be sure that your private lender reports the new lower monthly payment to the credit bureaus.

Digging Deeper: Tweaking monthly payments by selecting a new repayment plan isn’t the only move available to student loan borrowers who want to buy a home. Other strategies to prepare student debt for mortgage applications include removing cosigners and targeting individual loans.

Refinancing Private Loans for a Better DTI

One option to dramatically reduce the monthly bill on private loans is to refinance the debt.

Suppose a borrower has a $30,000 private student loan on a 10-year repayment plan. If the interest rate is 6%, the monthly payment will be just over $333. If that same loan gets refinanced into a 20-year loan at the same interest rate, the monthly payment drops to about $215.

Reducing the monthly bill by over $100 means the borrower can qualify for a large home loan. It could even be the difference between an approval or a rejection of a mortgage application.

The downside to this approach is that opting for a longer loan can sometimes mean a slightly higher interest rate.

Additionally, borrowers should use this option with care. Waiting until the last second to refinance your private loans can complicate the underwriting process on the home loan. Generally speaking, it is best to refinance at least a couple of months before starting mortgage applications. Talk with your desired lender to figure out an ideal timeline.

As of November, 2024, the following lenders offer the best interest rates on 20-year fixed-rate student loans:

Rank	Lender	Lowest Rate	Sherpa Review
1		6.08%*	Splash Financial Review
2		6.53%	ELFI Review
3		6.55%	Laurel Road Review

The post The Best Student Loan Repayment Plan for Getting a Mortgage and Buying a House appeared first on The Student Loan Sherpa.

However, focusing on student loans could mean putting off homeownership for years or even decades.

Finding an optimal strategy for balancing a desire for home ownership with your need to eliminate student debt isn’t easy. There isn’t a simple answer, and there isn’t an equation that will spit out the right decision.

The good news is that student loans don’t necessarily mean you can’t buy a home, and saving for a home doesn’t mean you have to be irresponsible with your student loans.

If you ask the right questions, you can find a realistic strategy that best fits your needs.

Interest Rate Considerations

Interest rates are vital when deciding whether to save for a down payment or eliminate debt.

If your savings account offers a 1.20% interest rate and your student loan charges a 9.60% interest rate, it might seem like paying down student debt is the obvious decision.

However, our analysis doesn’t end with a simple rate comparison.

For example, you could move your money to a different bank that offers a better interest rate. Some banks are now paying over 5% on savings accounts and CDs.

Likewise, there are options for student loans. If you have federal loans, paying the minimum and working towards forgiveness might be the best approach. If you have private loans, refinancing the debt with a new lender could lower the interest rate considerably.

In other words, even if you currently have a brutally high student loan interest rate and an atrociously low savings account interest rate, there are fixes available.

Your Goals Matter

The math on whether or not home ownership is a good idea is notoriously tricky.

The simple version is that the longer you stay in your house, the more it makes sense to buy.

Some factors go beyond building assets. You might want to live closer to family or work. Owning a home might be a major life goal.

If buying a home is important to you, it should be a consideration. Your happiness matters.

I’m not saying you should ignore your student loans and buy whatever makes you happy. Instead, I’m saying that your non-financial priorities also matter.

Sherpa Thought: A lot of personal finance advice makes judgments about right and wrong.

While some moves are objectively bad ideas or inherently risky, in many other cases, it comes down to personal preferences. The right decision for you may not be right for someone else.

When Student Loans Should Ge Paid Off First

There are situations where addressing your student debt is an obvious choice.

You might have so much student debt that you cannot qualify for a mortgage. If student loan payments eat up 40% of your income, there probably isn’t room for a home loan, and a mortgage company won’t lend you any money.

This doesn’t necessarily mean that you have to pay off all of your student loans, but it does mean that eliminating some of those loans may be required.

If you are in this situation, talking to a mortgage lender might be a good idea. Discuss which loans are the biggest issue on your credit report. It won’t necessarily be the loan with the highest interest rate. Sometimes it makes sense to attack a loan with a small balance but a large monthly payment.

Figure out the loan that is the biggest issue and attack it.

You can revisit the home mortgage question once your student debt situation becomes more manageable.

Student Loans Could be an Afterthought

In some cases, your student loan balance doesn’t matter.

Suppose you have over $100,000 of student loan debt. If that debt is federal and you work towards forgiveness, student loans shouldn’t change your plans.

Your monthly student loan payment will impact your Debt-to-Income ratio and potentially reduce home buying power. However, this situation may not change for over a decade.

Student debt will probably make buying a home more of a challenge, but paying them off first, or paying extra, doesn’t make sense.

Sherpa Tip: Sometimes, changing repayment plans is the only step needed to get student loans ready for a mortgage application. In many cases, picking the right repayment plan makes qualifying for a mortgage significantly easier.

Strategy for Borrowers Caught in the Middle

If you don’t fall into one of the aforementioned categories, figuring out the best approach can be complicated.

In this instance, I’d suggest building up a large emergency fund. For starters, having an emergency fund isn’t just a luxury — it is a necessity.

This exercise can provide valuable insight into the down payment question. You might look back after a few months and see that saving isn’t going well, and it is better to focus on your debt. You might also discover that you are doing well saving, and a down payment is a reasonable goal.

If your emergency fund grows beyond what is necessary, you can either use the money for the down payment on your mortgage or knock out a huge chunk of student debt.

There isn’t a substitute for personal experience, and spending several months saving can provide valuable insight. Plus, that emergency fund could come in handy.

Tips and Other Items to Consider

• You don’t need a 20% down payment. The conventional wisdom used to be that you needed a 20% down payment because it avoided PMI. For a student loan borrower, this is an especially difficult goal. Setting aside 3-5% may be sufficient for your needs.
• Don’t forget other debts. If you have credit card debt charging 20%, that is item number one on your to-do list.
• Make sure home ownership is right for you. Some people prefer to rent. Others have to move often for work. Buying a house and selling it a year later is usually a costly mistake.
• Use this time to learn. While you are getting your finances in order, take the opportunity to learn. Talk to mortgage lenders. Find a buyer’s agent and start looking at homes.

Most importantly, take a detailed look at your student loans and figure out how to optimize them for the mortgage application process.

The post Should I Save for a Home Down Payment or Pay Off Student Loans? appeared first on The Student Loan Sherpa.