Many borrowers are not sure how underwriters consider student loans and debt when they apply for a HELOC line of credit as a homeowner. Student loans differ slightly from other types of debt and generally have less impact than credit card debt, for example. In fact, student loans don’t always appear on your credit report, so it won’t affect the credit check portion of your HELOC loan application. Smart Lending can help you shop the best banks and lenders for refinancing student loans, consolidating debt and taking out a HELOC or home equity loan for the best rates and terms.
A Home Equity Line of Credit which most lenders refer to as a HELOC is a popular type of credit line that allows homeowners to borrow against the equity in their house. It’s often used for major expenses such as home improvements, debt consolidation, or other large purchases. However, when applying for a HELOC or home equity loan, mortgage lenders closely scrutinize a borrower’s financial situation, including their existing debts.
One common question that arises during this loan process is: Are student loans considered as debt when getting a HELOC? The simple answer is yes, student loans are considered debt when applying for a HELOC. Lenders assess your total financial picture, including any existing debts such as student loans, to determine your eligibility and how much you can borrow. In this article, we’ll explore how student loans impact the HELOC application process, what lenders look for, and how to best prepare if you have student loan debt but are considering applying for a HELOC or an equity loan.
How Student Loans Affect Your HELOC Application
Now that we know how DTI ratio works, let’s look at how student loans specifically impact your HELOC application:
- Increased DTI Ratio The most direct way that student loans affect your HELOC application is by increasing your DTI ratio. Since student loan payments are considered debt, they reduce the portion of your income available to take on additional debt. If your student loan payments are significant, they could push your DTI ratio above the lender’s acceptable limit, making it more difficult to qualify for a HELOC. For example, if you have a monthly income of $6,000 and $1,200 in monthly student loan payments, your DTI ratio would already be at 20%. If you have other debts, such as a car loan or credit card payments, your DTI ratio could climb even higher. Lenders typically prefer a total DTI ratio under 43%, so it’s important to factor in your student loan payments when calculating your ability to qualify for a HELOC.
- Impact on Credit Score: Your credit score is another important factor lenders consider when reviewing your HELOC application. Having student loans in and of itself does not negatively impact your credit score, as long as you make on-time payments and manage the debt responsibly. In fact, student loans can even help you build a positive credit history if you consistently meet your repayment obligations. However, missed or late payments on student loans can hurt your credit score, which may affect your HELOC eligibility. Most lenders require a minimum credit score of around 620 to qualify for a HELOC, though some may have higher thresholds. A lower credit score could lead to higher HELOC interest rates or denial of the loan altogether.
- Loan Repayment Terms and Options: Another factor to consider is the repayment terms of your student loans. Many student loans offer flexible repayment options, such as income-driven repayment plans, deferment, or forbearance, which could lower your monthly payment or temporarily pause it. While these options can reduce your DTI ratio and make it easier to qualify for a HELOC, lenders will still consider the full amount of your student loan debt. Some HELOC lenders may also view deferred student loan payments differently. Even if you are currently in deferment and not making payments, lenders may still count the potential monthly payment as part of your DTI ratio, especially if the deferment period is temporary. Make sure to clarify how your lender treats deferred or income-driven student loan payments when applying for the best HELOC lenders online according to the RefiGuide.
Strategies to Improve Your HELOC Eligibility with Student Loans
If you have student loans and are concerned about how they will affect your HELOC application, there are several strategies you can use to improve your eligibility:
- Pay Down Existing Debt: One of the most effective ways to lower your DTI ratio and improve your chances of qualifying for a HELOC is to pay down existing debt. If you have high balances on credit cards or personal loans, consider focusing on paying those off before applying for a HELOC. Reducing your total debt load will lower your DTI ratio and free up more of your income for additional borrowing.
- Refinance Your Student Loans: If your student loan payments are high, consider refinancing your student loans to lower your interest rate or extend the repayment term. This can reduce your monthly payment, which in turn lowers your DTI ratio. Keep in mind that while extending the term of your student loans can lower your DTI, it may increase the total amount of interest you pay over time. Additionally, refinancing federal student loans with a private lender will mean losing access to certain benefits, such as income-driven repayment plans or loan forgiveness options, so it’s important to weigh the pros and cons before refinancing.
- Increase Your Income: Increasing your income is another way to improve your DTI ratio. Whether through a salary increase, part-time work, or other income-generating activities, boosting your monthly income can lower your DTI ratio and make it easier to qualify for a HELOC. Lenders look favorably on borrowers with higher incomes, as it suggests a greater ability to repay the loan.
- Choose an Income-Driven Repayment Plan: If you’re on an income-driven repayment (IDR) plan for your student loans, your monthly payment is tied to your income rather than the total loan amount. This can result in lower monthly payments, which may help improve your DTI ratio. However, keep in mind that the total amount of debt will still be considered by the lender.
- Work with a Financial Advisor: If you’re unsure about how your student loans and other debts will impact your HELOC eligibility, consider working with a financial advisor. A financial advisor can help you create a strategy to manage your debts, improve your credit score, and strengthen your overall financial profile before applying for HELOCs or home equity loans.
Are Student Loans Included in the Debt to Income Ratio?
This means that necessary monthly expenses are factored into your debt to income ratio or DTI, while discretionary purchases you make each month aren’t considered. Bills that contribute to your debt to income ratio calculation include: student loans. (both private student loans and federal student loans)
Can you use a HELOC to Pay Off Student Loans?
Yes, you can use a Home Equity Line of Credit (HELOC) to pay off student loans. A HELOC is a line of credit secured by the equity in your home, allowing you to borrow against the value of your property. The amount you can borrow depends on your home’s equity, as well as factors like your credit score and income.
Similar to a credit card, a HELOC gives you access to funds as needed, with the option to make minimum payments on the borrowed amount. HELOCs have a set draw period, typically around 10 years. During this time, you can borrow from the line of credit, but once the draw period ends, no further withdrawals are allowed, and you must begin repaying the remaining balance.
You could use a HELOC to pay off one or more of your student loans, shifting your debt payments from your student loan servicer to your HELOC lender.
Using a HELOC to pay off student loans carries certain risks. While HELOCs often offer lower interest rates and may have more flexible eligibility criteria, they are secured by your home, meaning your property is at risk if you fail to make payments. Many homeowners have had success consolidating debt with a home equity loan.
Below, we’ll explore the risks and benefits of using a HELOC or home equity loan to pay off student loans further.
Lower interest rates: HELOCs typically offer lower rates than student loans, potentially saving you money over time.
Flexible borrowing: You can borrow as needed during the draw period, giving you control over how much you use to pay off private student loans. Learn how the HELOC interest is calculated compared to your student loan interest.
Secured by your home: Failing to repay the HELOC could put your home at risk of foreclosure.
Variable interest rates: Many HELOCs have variable rates, which could increase over time, raising your monthly payments.
Carefully consider these pros and cons before using a HELOC to pay off student loans.
What Is a HELOC and How Does It Work?
Before diving into the specifics of how student loans affect HELOC eligibility, it’s important to understand what a HELOC is and how it functions.
A HELOC is a revolving line of credit that allows homeowners to borrow against the equity in their home. The HELOC is considered a second mortgage loan. Equity is the difference between the current market value of your home and the amount you owe on your mortgage. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity.
With a HELOC, you can typically borrow up to 85% of your home’s equity. In the above example, if you have $100,000 in equity, you might be able to borrow up to $85,000 through a HELOC. Unlike a home equity loan, which provides a lump sum of money, a HELOC gives you access to a revolving line of credit, similar to a credit card. You can withdraw funds as needed during the draw period, usually lasting 5 to 10 years, and only pay interest on the amount you borrow. After the draw period, you enter the repayment phase, during which both principal and interest must be repaid.
How Lenders Assess Debt When Applying for a HELOC
When you apply for a HELOC, lenders assess your financial profile to determine your ability to repay the loan. One of the most important factors they consider is your debt-to-income (DTI) ratio. Your DTI ratio is a percentage that compares your total monthly debt payments to your gross monthly income.
For example, if your monthly income is $5,000 and your total monthly debt payments are $1,500, your DTI ratio would be 30% ($1,500 ÷ $5,000 = 0.30 or 30%).
Lenders generally prefer borrowers with lower DTI ratios because it indicates that you have a higher portion of your income available to repay new debt. Most lenders require a DTI ratio of 43% or lower to qualify for a HELOC, though some may have stricter or more lenient requirements depending on other factors like your credit score and home equity.
Student loans, like all other forms of debt, are included in your DTI calculation. This means that if you have student loan payments, they will be factored into the total monthly debt payments that lenders use to assess your financial health. How long does it take to get a home equity loan?
Other Considerations When Applying for a HELOC
In addition to your DTI ratio and credit score, lenders will also consider other factors when reviewing your HELOC application, including:
- Home Equity: Most lenders require that you have at least 15% to 20% equity in your home to qualify for a HELOC. If your home’s value has appreciated since you purchased it, you may have built significant equity that can help offset the impact of student loan debt.
- Loan-to-Value Ratio (LTV): The LTV ratio compares the amount of your mortgage debt to the value of your home. Lenders generally prefer an LTV ratio of 80% or lower, meaning you should owe no more than 80% of your home’s value. The more equity you have in your home, the more likely you are to qualify for a HELOC.
- Interest Rates: HELOCs typically come with variable interest rates, meaning your monthly payments could increase or decrease based on market conditions. It’s important to consider how rising interest rates could impact your ability to repay the loan, especially if you’re already managing student loan payments.
Yes, student loans are considered debt when applying for a HELOC, and they can impact your eligibility by increasing your debt-to-income ratio. However, having student loans does not automatically disqualify you from getting a HELOC. Lenders take a holistic approach when evaluating your financial situation, considering factors like your income, credit score, home equity, and overall debt load.
Smart Lending recommends that you get advice from your trusted financial advisor in regards to managing your student loans responsibly, paying down other debts, and considering strategies like refinancing.
