We’ve been hearing the dire warning for years: The $1.3 trillion Americans collectively owe in student loan debt is dragging down the housing market. Millions of young people can’t become homeowners because they’re stuck paying off tens — if not hundreds — of thousands of dollars in college debt.
Well, it turns out borrowing to pay for college won’t necessarily doom you to a lifetime of renting. Research from the Board of Governors of the Federal Reserve System suggests having student loans isn’t the barrier to homeownership many thought it was. Rather, having a college education makes it more likely you’ll buy a home than someone who didn’t go to college, even if you did take out student loans, as Susan Dynarkski, an economist with the Brookings Institution, explained in a blog post.
In 2014, Harvard economist Larry Summers singled out student loan debt as a factor keeping first-time buyers out of the housing market. The same year, a study by John Burns Consulting concluded 414,000 fewer homes were sold in 2014 because heavily indebted borrowers couldn’t afford to buy.
Most notably, a 2013 Federal Reserve Bank of New York analysis found rates of homeownership among 30-year-olds with student debt fell more dramatically after the recession than those of their peers without debt. Though people with student loans had historically been more likely to own homes than those without debt, “by 2012, the homeownership rate for student debtors was almost two percentage points lower than that of non-student debtors,” the researchers noted.
Want to buy a home? Go to college
The more recent Board of Governors study took a closer look at the much-cited New York Fed research and zeroed in on a problem. The economists, working with data gathered from credit reports, had combined all debt-free individuals into one group, whether they had earned a college degree. Then, they compared their homeownership rates with those of people with student loan debt, possibly skewing the results.
Many people looked at the study results and assumed student debt was making it more difficult for college-educated people to buy homes. But the data didn’t actually support such a conclusion, according to Dynarski.
“It got sort of lodged in people’s minds that student debt was dragging down homeownership, but the evidence really doesn’t support that,” Dynarski explained to the Washington Post. “The dividing line between the haves and have-nots is not student debt, it’s a college education.”
The second group of Fed economists used data from the National Student Clearinghouse to divide debt-free individuals into two groups: those who attended college and those who did not. They also looked at homeownership rates at different ages. The data did show that people without debt became homeowners sooner than those with debt, whether they went to college or not. But by the time they reached their early 30s, college-educated people with debt were just as likely to have bought a home as people who attended college and had no debt.
“By the time people are in their 30s, when the typical borrower would have finished paying off her student loans, the home ownership rates of the two college-educated groups are statistically indistinguishable,” Dynarski wrote. “The striking, large gap is between the college-educated and those who stopped with high school.”
At age 35, those with a college education were 14% more likely to have bought a home than those who didn’t go to college. While it seems taking on student loans delays homeownership, borrowers eventually catch up to those who went to college debt free. Those who didn’t go to college get left behind.
“[T]he college-educated — even those with student debt — are winners in our economy,” Dynarkski concluded.
The Fed study isn’t the only one challenging the conventional wisdom on student debt and homeownership. A report from real estate website Zillow found student loans had a negligible effect on homeownership. However, borrowing to pay for college but not earning a degree does depress homeownership rates, Zillow found.
While people who complete their degree are more likely to get a job that allows them to afford loan payments and eventually save for a down payment, borrowers who don’t finish school are more likely to be stuck in low-wage jobs and have difficultly getting ahead.
“Folks with a degree … are able to pay their loans, they are able to buy homes,” Dynarski told the Post. “It’s the people who have low earnings, who are dropping out of community colleges and for-profit colleges who are having problems.”
If you do have student loan debt and would like to buy a home, what should you do? Read on for three tips on how to make your dream of homeownership a reality.
1. Fix your debt-to-income ratio
Loads of student loan debt combined with a small-ish salary and little savings are a recipe for a mortgage loan denial. Before they’ll give you money, a lender looks at your debt-to-income ratio, or your monthly debt payments (including existing loans and your prospective mortgage) as a share of your total income. Lenders don’t like to see you spending more than 36% of what you earn on debt, according to Bankrate, so if your debt will be too high, you’ll probably be denied.
If your debt-to-income ratio makes it hard for you to get a mortgage, there are a few things you can do to solve the problem. One is to earn more money. Finding a side hustle, getting a better-paying job, or signing up for overtime will not only will increase your income (improving your DTI ratio), but you’ll also be able to save more for a down payment. A bigger down payment translates into a smaller mortgage, and a better DTI. Meanwhile, cutting spending will give you more money to save for a down payment or aggressively pay down your student loans.
To keep your DTI ratio healthy, avoid racking up debt on your credit cards (or pay it down if you already have a balance). If a large fixed monthly student loan payment is still standing between you and a mortgage loan approval, switching to a new repayment plan (like an income-based or extended plan) could also improve your DTI ratio. Consolidating or refinancing your student loans may also lower your monthly payments.
2. Keep your credit clean
A low debt-to-income ratio won’t be enough to get you into your dream home. Sparkling credit is also key if you’re angling for the lowest possible mortgage rate. Don’t let missed or late payments on student loans or other debt tarnish your credit report. Also, keep your credit utilization ratio low by using no more than 30% of your available credit at a time, even if it means making multiple payments during the same month. Or, ask your card issuer to raise your limit, which will improve your ratio.
You’ll also want to make sure that errors that could lower your credit score don’t creep onto your report. You can request a free credit report from each of the three major reporting agencies once a year. Check one report every few months by spacing out your requests throughout the year.
Finally, once you feel you’re ready to apply for mortgage, don’t apply for any other loans. Requests for a car loan or a new credit card can temporarily ding your credit score, making it harder to get the mortgage you want.
3. Get around 20% down
Even if you have great credit and a strong debt-to-income ratio, there’s still another mortgage hurdle to cross: the down payment. High rents and home prices in some parts of the country make it difficult for many young people to save for a substantial down payment while also paying down student loan debt. Fortunately, there are ways around the savings problem.
One is to dial down your expectations for a home. Settling for a less-expensive starter home without all the fancy amenities means you won’t have to save up for a massive down payment. If cheap homes are nowhere to be found, it might be time to consider alternatives to 20% down. Low-money-down loans from the FHA, VA, and some banks can make it easier for you to buy. Payment assistant programs for first-time or low-income buyers and cash gifts from family (if you’re lucky) can also help.