If you’re preparing to buy a home and have federal student loan debt, here are a few things to consider.
Student loan debt and your mortgage application
Like most forms of debt, student loans provide an opportunity to build your reputation as a borrower. By making the minimum payment on time, you can demonstrate your commitment to meeting your financial obligations. Especially for younger consumers who may have had limited opportunities to build credit, student loans can be one of their first opportunities to start building their credit report.
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However, it’s important to remember that creditors will consider your debt-to-income and debt-to-available-credit ratios. If you want to take out a large mortgage and your income or remaining credit is insufficient, lenders may be reluctant to invest in you, which could increase your interest rate. If you plan to buy soon, consider expediting the repayment of your student loans or other line of credit to even the ratio.
How student loan debt compares to other debt
Much like a car loan or mortgage, student loans are categorized as installment loans. The borrower repays the original amount plus interest over a period of time. After repayment of the loan, the account will be closed. For federal student loans, interest rates are fixed and tend to be lower. Payback plans typically reflect that graduates are just beginning their careers and are likely to earn an entry-level pay.
Federal student loans differ from credit card debt in several ways. Credit card interest rates tend to be more volatile and fluctuate more depending on the economic climate. So while you might want to prioritize paying off student debt to improve your debt-to-income ratio, it’s important to balance this with paying off credit card debt to bring more structure, stability, and predictability to your finances.
Prepare and secure loans for the future
After more than two years of government leniency, use the next few months to prepare for payments to resume. Especially if you graduated during the pandemic, you may still have a payment to make. So this is an opportunity to review and familiarize yourself with the process.
First, make sure you know who you have to pay back. Since the payment pause began, you may find that you now owe payments to another student loan servicer. If you make payments to the wrong service provider, correcting the error can be a headache and affect your credit report and credit score.
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If you have questions about who your servicer is, visit studentaid.gov or call 800-433-3243. If you have a new servicer, arrangements like Autopay may not have been set up, and the resulting missed payments could end up on your credit report.
Also, confirm that you understand how the payments are to be made, what your monthly payment will be, when the payments are due, and your adjusted schedule for repaying all money, taking into account the shift.
If you can determine the exact amount you need to pay, save that amount or prepare to save that amount on each paycheck, perhaps in $50 increments, until the payment is due.
Don’t pay the loan until you have to because there is a chance of federal forgiveness or another extension, but get used to paying the loan to yourself. Over time, these funds will grow, giving you a cushion in case of an emergency or when you want to buy something special.
If you were struggling to make your payments before the moratorium went into effect and missed several months, make sure the account is still with the federal loanholder and hasn’t been wired to a collection agency. If you owe a collection agency money — whether it’s student loans or not — it’s important to prioritize those payments now so your credit can recover before a mortgage loan application.
You can also use the next few months to ensure you have enough income and savings to start making regular payments from September. First, verify your student loan payment information and check your credit report weekly for free at annualcreditreport.com.
Francis Creighton is President and CEO of the Consumer Data Industry Association based in DC