The cost of tuition is rising as the number of people with massive student debt totals is also increasing. So it’s not shocking to see that the home ownership rate has started decreasing. This shouldn’t come as much of a surprise. People who have huge amounts of debt aren’t exactly jumping for joy at the prospect of adding a mortgage to the mix. You would never guess it, but sometimes student debt can be an advantage when buying a house. Here’s how student loan debt can help you purchase a house.
A study conducted by CoreLogic has demonstrated that in reality there are many ways which carrying student debt can improve a person’s creditworthiness when they are applying for a mortgage.
About the CoreLogic Study
The study compared many people’s ScorePLUS score, which is a measurement of how likely someone is to default on their lease in the following year. In 2010, as well as in a more recent version of the study in 2015, the researchers found that people who were 20-36 (also known as Millennials) had a far lower ScorePLUS score when they had higher student debt. That means that people with more student debt were having a lower chance of defaulting on their lease or making later major payments.
Why would this be?
How student loan debt helps your credit
Essentially, your credit score and credit health are not just based on your loan balances, although that is certainly a factor. Your credit score (a good predictor of default) comes from a few different aspects of your money management skills, including:
- Your debt-to-credit ratio, or how much of your available credit you are using
- Whether or not you regularly make your payments on time
- Type of loans and diversity of accounts
- Number of accounts open
- And much more
Therefore, making regular on-time payments on your student loans can help your credit! That even applies if you have massive loan totals. Mortgage lenders are much more interested in how well you manage your credit, not your total debt amount. They also look at your income to predict your ability to pay off your mortgage. So if you have a lot of debt but are on a good career track, that will help your chances.
However, the opposite is also true. If you make late payments on your student debt and do not manage it in a responsible manner, it will show on your credit report. This will make it much harder to have a successful mortgage application.
Why does it matter that student loans are installment loans?
Student loans are installment loans. That means that they are loans taken out which are paid back at regular intervals. Typically monthly or bimonthly, with payments of the same amount. Other examples of installment loans include:
- Mortgages
- Car or motorcycle loans
- Home equity loans
[tweet_box design=”default” float=”none”]Installment loans impact your credit history much different than revolving debt, like credit card payments, hospital bills, or other short-term debt. [/tweet_box]There are a few reasons for this. First, installment loans are often backed by some major collateral, or by a cosigner. Therefore, there is much more incentive to pay the mortgage on time each month at the risk of financial losses. Second, since installments loans are by nature more long-term, the actual amount of the loan doesn’t matter so much. This is because lenders expect the balance to be relatively high for the first few years.
Installment loans are more important in that they can demonstrate financial responsibility by making regular payments. If creditors want to look at your ability to pay the actual amount of a loan on time, they will look to more short term things like credit card payments, or they will look at your overall income.
Surprisingly, when you pay off your student loans, you might see a small decrease in your credit score. Your debt overall has declined, but your creditworthiness is not as good. Why?
Student loans are installment loans so they add diversity to your credit portfolio and demonstrate that you can pay off a variety of different loan types. Once the loan is paid, the account is closed, and you have one less type of loan in your name. Therefore, having your student debt account open can increase your likelihood of securing a mortgage. It makes sense to wait until you have your mortgage to fully pay off the student loans.
In conclusion, student debt can help you buy a house because lenders don’t always care if you have a lot of debt, as long as you can manage it responsibly over the years.
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