After graduating from college and getting a job, the next step is usually finding a place to live. Unless your parents are the most fantastic people ever, you might be looking to rent or buy.
One of the most essential factors in getting approved for a lease or a mortgage is your credit score. A credit score is a number that determines your worth to a lender when it comes to borrowing money and paying it back. The range is between 300-850, and the higher the score, the better. Your credit score is based on how many open accounts you have, repayment history, and total debt.
Student loan debt plays a significant role in credit score and can be beneficial. If monthly payments are made on time, it will increase the score, especially if you do not have other debt. Lenders look at the debt-to-income ratio, the amount paid towards debt versus the amount made through income each month. The best thing to do is make payments on time and in full. However, defaulted loans will harm your credit score.
Federal Student Aid defines default as “Failure to repay a loan according to the terms agreed to in the promissory note. For most federal student loans, you will default if you have not made a payment in more than 270 days.” One day late on a payment, and you become delinquent. A delinquent loan means you missed a due date. You have 90 days until your credit score is affected. Late payments will stay on your credit report for seven years.
Some loan providers’ default status dates may vary, so make sure to check your loan agreements. The most used scoring model is a FICO Score, 35 percent to your payment history. If you have several loans from the same lender, one missed payment can significantly damage your score. When looking to purchase a home, you need to be confident you can afford a mortgage.
Lenders look at the amount allocated to debt payments versus your monthly income-this analysis is known as your debt-to-income ratio (DTI). DTI has two parts: the front-end ratio and the back-end ratio. The front-end ratio is the percentage of income spent on housing payments, and the back-end ratio is the percentage of income spent on all debts, including housing. Lending Tree reported that most lenders want borrowers to maintain a front-end ratio of less than 28 percent and a back-end ratio of less than 36 percent. So, if your DTI is 36 percent or higher, you may want to consider putting off purchasing a home until you have paid off your student loans.
Besides earning a higher income, decreasing student loan payments is one way to lower your DTI. If you choose an income-driven repayment plan for federal student loans, your payments will not exceed 10 to 15 percent of usable income. Income-driven repayment plans are more affordable because they are less than standard or graduated plans, but you will be paying for 20 to 25 years. If you don’t have much debt other than student loans, you are in a better position to get approved for a home loan. Perhaps it would be wiser to pay off student loans before becoming a homeowner.
There are several repayment plans from which to choose. The Standard Repayment Plan is the most basic, where payments are fixed and made for ten years. Monthly payments for this plan are usually higher than those of other plans, but the balance will decrease faster. The faster a loan is paid off, the less interest. This plan is the default if you do not choose a different plan.
The Graduated Repayment plan starts with low payments but gradually increases every two years over ten years. This plan would suit people who begin with a low income but expect to make more money progressively.
Income-driven repayment plans are better if federal student loans are higher than income. Revised Pay As You Earn (REPAYE) Repayment, Pay As You Earn (PAYE), and Income-Based Repayment (IBR) are based on income and family size. Payments are recalculated every year, adjusting to changes.
The payments are more affordable because they are income-based, which means they will not exceed 10 to 15 percent of usable income, and monthly payments will be less than the standard or graduated plans. Each of these plans lasts for 20-25 years.