What to do if your student loan makes it hard to get a mortgage?

An education loan can impact the credit scores of even your parents if they are co-borrowers, as they would have an equal liability in your debt.

What to do if your student loan makes it hard to get a mortgage

The great Italian political thinker Niccolò Machiavelli once famously said that the end justifies the means. But what if the means, howsoever justified, somehow also proves to be a stumbling block to achieving the end? That would indeed be ironical.

Imagine taking a student loan to finance a better education and a better life, only to default on repayment and see it proving to be a hindrance to achieving that better life – such as purchasing a dream house or apartment on loan.

This may seem ironical, but it is also an eminently likely situation. And It can happen because before sanctioning a home loan, banks and other lenders will evaluate your credit history. If have a low credit score, they are likely to reject your loan application.

What compounds the problem is the fact that you won’t be able to maintain a healthy credit score if you have pre-existing dues – such as an unpaid student loan. In fact, even your application for a new credit card can get rejected for this reason.

The perils of defaulting

It is not only purchasing a new home on loan or a getting a credit card that can become difficult; an outstanding student loan can have other consequences as well, and harsh ones at that. For instance, if your parents are co-borrowers or guarantors, they would have an equal liability and their credit scores would get impacted too.

In India, students and their parents don’t seem to realise the seriousness of the problem. Data from the Indian Banks Association (IBA) shows that India’s education loan segment has been seeing loan defaults rising steadily over the past few years; from 7.3% in March 2016, it climbed to almost 9% by March 2018.

Does this mean that repaying an education loan is actually harder than what students and parents imagine? Are students, in their desire to get that extra edge in the job market through a better college education, getting sucked into a loan trap? Is it so difficult to avoid defaulting on an education loan, and consequently marring one’s credit score?

Relax. An education loan is not something to be looked at with suspicion, but do remember that such a loan, like any other loan, needs to be repaid. If you are clear about that and disciplined about finances, you can repay all dues (in effect, improve your debt-to-income ratio) and make a clean beginning.

If you find yourself on the verge of defaulting on your student loan and jeopardising your dreams of owning an apartment, here are some options that you can explore. 

Loan restructuring

First, you must take steps to bring your debt-to-income ratio under control. One immediate way to do this is to get the relevant bank to restructure your student loan. This is not an unreasonable request, especially in these pandemic-hit days.

What’s more, banks are known to restructure loans to help students clear their dues, and they do this by increasing the loan tenure and reducing the EMI. In any case, they usually allow a moratorium period of 6-12 months after a student borrower’s course is completed. 

As banks have to recoup their investments, you can expect the lending bank to accede to your request and increase the loan period further if they feel it would help you pay them back.

Loan refinancing

You could also look at refinancing your current loan if you feel the terms are too stiff. But ensure that you are offered a lower monthly payment rate and lower EMI amount. This will give you some relief in making repayments, helping you improve your debt-to-income ratio. The refinancing will, of course, mean your repayment term is likely to get lengthened – that is, you will be paying more over the tenure of the loan. However, the lower interest rates will give you more breathing space.

Refinance companies service loans from Rs 2 lakh to Rs 1 crore. Their clientele includes students with existing education loans, working professionals like you who are servicing an existing student loan, and even co-borrowers. They will, however, ask for collateral, which can be fixed deposits or property (except agricultural land).

Settling card dues

Alongside the first two steps, which basically deal with lenders, you can do something on the personal front to improve your debt-to-income ratio: pay off your credit card outstanding amount. If you can do that, you vastly enhance your chances of qualifying for a home loan.

Remember, you will have control over how quickly you want to square your card dues. Unlike other forms of debt where the monthly payments are fixed, you are at liberty to make more payments than the minimum due on your credit card – the more you pay, the lower your minimum monthly payment will be.

Each payment will bring down your pile of debt by that much, which will improve your debt-to-income ratio. It would be even better if you are able to pay off your credit card balance in full each month. When the loan balance is zero, your credit score will improve automatically as there will be no debt (that is, no monthly obligation) to factor into your debt-to-income ratio.

If you have multiple cards, you can follow either the ‘debt avalanche’ method or the ‘debt snowball’ method to pay off your dues. In the former, you make minimum payments on all debts (across cards), then use any remaining money to pay off the debt with the highest interest rate. With the latter, you make minimum payments on all debt, then pay off the smallest debts first to get them out of the way before moving on to bigger ones.

If you plan to take a new credit card, don’t close the old one(s); keeping older accounts open will have the benefit of a longer average credit history and a larger amount of available credit. But do be timely with your payments – for both and new accounts.

Taking help from family

This may not always be possible, but in case a close family member has an ongoing home loan, it can open up an option for you to explore. It works this way: you could request them to take a top-up on the loan amount and use that amount to repay your education loan. You can always pay the EMIs on this top-up, but it depends on your salary and your capacity to pay.

Of course, asking close family members to help out financially is not always advisable as it can lead to souring of relations, but if it is possible, it is definitely better than taking a personal loan to service an education loan.

Last words

All the suggestions made so far pertained to dealing with debts and credit scores; however, there's something outside finance that you can do when your home loan application is being processed: try and avoid hopping jobs.

Lenders are comfortable with job stability among borrowers, so unless a new job increases your income substantially, it is advisable to stick on at your current job – or at least till the home loan process is complete. This becomes even more crucial, given that the student loan (and any other debt you may have) has already complicated matters. 

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