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If you’re gearing up to buy a home and have federal student loan debt, here are a few matters to consider.
Student loan debt and your mortgage application
Like most forms of debt, student loans present an opportunity to build your credit reputation. By making the minimum payment on time, you can demonstrate your commitment to meeting your financial obligations. Particularly for younger consumers who may have had limited chances to build credit, student loans may be one of their first opportunities to begin building their credit report.
It is important to keep in mind, however, that creditors will consider your debt-to-income and debt-to-available credit ratios. If you’re looking to take out a large mortgage and your income or remaining credit doesn’t stack up, lenders may be more hesitant to invest in you, which could increase your interest rate. If you’re looking to buy soon, you may want to expedite paying down your student loans or other lines of credit to balance out the ratio.
How student loan debt compares to other debt
Similar to an auto loan or mortgage, student loans are categorized as installment loans. The borrower pays back the initial amount, in addition to interest, over a period. Once the loan has been paid back, the account is closed. In the case of federal student loans, interest rates are fixed and tend to be lower. Payback plans typically reflect that graduates are just starting in their careers and are likely to earn 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 may want to prioritize paying down student debt to help your debt-to-income ratio, it’s important to balance that with paying down credit card debt to bring more structure, stability and predictability to your finances.
Prepare and shore up credit for the future
After more than two years of government forbearance, you should use the next several months to prepare for payments to resume. Especially if you graduated during the pandemic, you may have yet to make a payment, so this is an opportunity to review and familiarize yourself with the process.
First, make sure you know whom to pay back. Since the payment pause began, you might discover that you now owe payments to a different student loan servicer. If you make payments to the wrong servicer, the error could be a headache to correct and could harm your credit report and credit scores.
If you have questions about who your servicer is, visit studentaid.gov or call 800-433-3243. If you have a new servicer, arrangements such as autopay may not have been set up, and resulting missed payments could end up on your credit report.
Further, confirm that you know how to make the payments, how much your monthly payment will be, when payments are due and your adjusted timeline to pay all the money back, accounting for the shift.
If you can determine the precise amount you will need to pay, start saving that amount, or prepare to save that amount every 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 some federal forgiveness or yet another extension, but get into the habit of paying the loan to yourself. Over time, you’ll see those funds grow, giving you a cushion in case of emergency or if you want to make a special purchase.
If you were struggling to make your payments before the moratorium went into effect and missed several months, verify that the account is still with the federal loan holder and hasn’t been transferred to a collection agency. If you do owe money to a collection agency — whether it’s related to student loans or not — it’s important to prioritize making those payments now so your credit has time to recover ahead of any mortgage loan application.
You can also use the next several months to ensure you have the income stream and savings to begin making regular payments starting in September. To get started, review your student loan payment information and check your credit report weekly and free at annualcreditreport.com.
Francis Creighton is the president and CEO of the Consumer Data Industry Association, based in D.C.
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