Consolidating Student Loans and Mortgages

While rising debt levels are partially responsible for a falling homeownership rate in the U.S., there are ways aspiring homeowners can responsibly take on a mortgage while working on paying down other loan balances. For example, a Credit.com reader recently asked us if there’s a way to get approved for a mortgage, despite having education debt.

“My Equifax report says 10 of my 14 direct service school loans are over the limit. I only started paying two months ago and am on time with full payment. Would consolidating those loans take this problem away? We are trying to buy a house and the lender said this is affecting my credit score.” — Stacy

If by “over the limit” you mean your current loan balances are higher than the amount you originally borrowed, that’s not surprising. Many student loans accrue interest before you enter repayment, and by the time your first bill comes due, the balance will likely exceed the original loan amount. Yes, credit scoring models generally ding you for having high loan balances relative to the original amount borrowed, but taking out a consolidation loan isn’t likely to help much in this area because you’ll have a high balance on that new loan. As for a loan balance affecting your credit score, the best thing you can do is pay it down.

That’s not to say student loan consolidation can’t help you get a home, because it can. Whether or not it’s the right move for you depends on your priorities. Heather McRae, a senior loan officer at Chicago Financial Services, said she encounters this question a lot, particularly when dealing with younger borrowers.

“In mortgage underwriting, one of the biggest factors is your debt-to-income ratio, and that’s specifically on a monthly basis,” McRae said. “If you have the ability to cut [your monthly payment] in half some way or cut it down in any regard, that will help you more easily qualify for a mortgage.”

Is This the Right Option for You?

Student loan consolidation can help you reduce your monthly student loan payments if you extend the loan-repayment term or get a lower interest rate on your loans. (Federal Direct consolidation loans average the interest rates of the loans being consolidated to determine the APR on the new loan, but you might be able to qualify for a lower APR by refinancing with a private lender. Keep in mind that consolidating federal loans with a private loan means you lose some of the repayment flexibility offered through the government.)

Say you have multiple student loans, and each of those loans has a 10-year repayment term, you could consolidate them into a 20-year repayment term and reduce your monthly student loan obligation. You may have more flexibility in your monthly budget, but a longer loan term usually means you’ll end up paying more in the end, unless you qualify for some sort of student loan forgiveness. Even then, you need to consider how much you may end up owing in taxes on forgiven debt.

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Figuring out the most cost-effective option can be tricky, but if you’re focused on buying a home in the near future and know your student loans are an obstacle between you and that goal, consolidation may be a viable strategy.

It’s Important to Plan Ahead

One more thing: If you’re thinking of consolidating your student loans to improve your chances of getting a mortgage, give yourself plenty of time to do it.

“It’s not good to do any sort of applying for other loans in the middle of when you’re trying to get a loan,” McRae said. She recommended planning ahead and talking to a mortgage professional if you have questions about how you can improve your chances of getting a home loan. “I talk to people a year or more ahead of time.”

Remember that checking your credit is an important part of financial housekeeping before you apply for any loan, especially when it involves buying a home, because a good credit score can save you a lot of money by way of a good interest rate. You can keep tabs on where you stand by getting a free credit score, updated every 14 days, on Credit.com.