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Qualifying for a Mortgage with Student Loan Debt

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As the cost of college tuition continues to rise, a total of 44 million people carry student loan debt. With an average balance of approximately $40,000, these high balances are creating roadblocks when it comes time to get preapproved for a mortgage.

Student loan debt can create big challenges when it comes to qualifying for a home loan, in some cases making it all but impossible. However, new lending guidelines in 2019 may bring some relief and options making it easier to get a mortgage even with large student loan balances.

In this article, we will cover:

Approaching a mortgage lender with student debt

One of the most important factors in getting approved for a mortgage is how much debt you have compared to your income. In lending, this is called your debt-to-income ratio (DTI), and lenders have maximum limits for this figure based on what type of program you are qualifying for. The more debt you have, the harder it will be to qualify for a mortgage.

If you have student loans, your payment will count toward that debt — so it’s important to be prepared when you’re looking to apply for a mortgage. You should first obtain your credit report to see how your student loans are being represented, so you can correct any errors in the monthly payments or balances before you begin the full loan application approval process.

Here are things a mortgage lender will want to know about your student loan.

What does your credit report show?

The first thing a mortgage lender is going to look at is your monthly payments on any debt, and that’s found on your mortgage credit report.  A mortgage credit report is slightly different from a regular consumer report because it accesses information from three credit bureaus instead of just one.

If you recently started your student loan repayment period, there should be a minimum monthly payment on your credit report. Make sure it’s correct — credit bureaus may have an automated system for calculating the minimum payment that could be much higher than what you actually pay. If the credit report doesn’t reflect your minimum student loan payment correctly, you’ll want to get it fixed by providing the actual payment schedule you received from your student loan company to the credit bureaus.

Are your loans still in deferment?

The period before any payments are due on a student loan is called deferment. If your loans are still in deferment, the lender will often count 1% of your total student loan debt as your monthly debt payment figure for qualifying purposes, which almost always results in a higher amount than you’ll actually pay. This makes it harder to qualify for the loan.

Lenders prefer to estimate on guessing your payment will be higher. That helps them avoid the risk that you’ll have trouble making your mortgage payment. It’s best to apply for a mortgage when your repayment schedule has already begun, so you don’t have any qualifying surprises that prevent you from buying the house you want.

What is the amortization schedule for your payment?

Student loans are usually repaid on a 10-year schedule, but that schedule may be longer for higher balances, especially if you request an income-based repayment schedule. Amortization refers to the the amount of principal and interest you pay on a monthly basis until your loan is paid off.

The principal is the amount that is actually reducing your loan balance, while the interest goes to the investor who made you the loan. At the beginning of your repayment, you pay more interest than principal. As time goes on, you pay more principal until the balance is paid in full.

Different loan programs will need to know the amortization period of your loan to determine if you qualify for a mortgage.

Income-based repayment schedules

An income-based repayment (IBR) schedule is something you apply for with the student loan lenders you borrowed from.  The repayment schedule is based on your income level, and can be very low — as low as $1 per month, depending on your income.

As your income grows, your monthly payment will grow as well. Each year, you provide income documentation to the lender to document your income so they can adjust your payment according to your salary.

When applying for a mortgage, you will need to show paperwork related to your IBR payments, especially if the monthly payment is very low. Not all programs allow the IBR payment to be used for qualifying.

How lenders look at your student loan debt in 2019

Until recently, lenders haven’t just looked at your actual monthly debt payment. Instead, they’ve counted 1% of your student loan balance as your effective debt for the purposes of qualifying for a mortgage. This means that if you have a $50,000 student loan balance, the lender is required to count 1% of the loan balance against you, which adds a $500 per month debt to your monthly debt. That’s true even if you’re only making a $200 monthly payments on the loan.

Here’s an example of how this student loan rule can hurt your qualifying chances. If you find a house that you like and need a $250,000 conventional loan, your monthly payment including taxes and insurance will be roughly $1,800. We’ll also assume you have a new job paying a $55,000 per year salary, and you have a $200 per month par payment to go along with a $50,000 student loan balance.

The maximum debt-to-income ratio for a conventional loan is 50%, so if we add the expected $1,800 mortgage and the car loan, that is $2,000 per month of debt. Divided into your monthly income of $4,583, your debt-to-income ratio is 43.6%. Once we add the minimum 1% student loan balance payment of $500, the debt-to-income ratio spikes up to 54.5%, and you no longer qualify to buy that home.

The good news is, new programs and guidelines have gone into effect that provide common sense alternatives to the older, more stringent rules. The guidelines vary from program to program, so be sure you have a basic understanding of them before you start shopping for mortgages.

For most student loan borrowers, lenders will now look at your actual payment amounts. If your loans are in deferment or if you’re on an income-based repayment plan, the rules have gotten a little more lenient in some cases.

Conventional loans and student loan payment

Fannie Mae and Freddie Mac are government-sponsored enterprises that purchase home loans from the lenders who make them. This allows mortgage companies to keep issuing more loans. Fannie and Freddie have specific rules on “conventional loans” that mortgage lenders need to follow if they want their loans purchased.

Conventional loans require that borrowers to have at least a 620 credit score. Debt ratio generally must be 45% or below, although exceptions are allowed up to 50% if you have higher credit scores and extra cash on hand after you close. Down payments can be as low as 3%.

Before the recent changes, these loans followed the 1% rule, preventing many people with high student loan balances from being able to qualify for mortgages. Now, both Fannie Mae and Freddie Mac will look at your actual monthly payment. They have also made changes that make it easier for borrowers to qualify with a variety of different student loan repayment options.

If you’ve started paying back your loans on an income-based repayment plan, Fannie Mae will now use your actual monthly payment to qualify you for a loan, even if it’s $0. If your loans are deferred, the lender will use the amount your actual payment will be once you start paying down your student loan.

Freddie Mac’s loan changes are similar to those made by Fannie Mae, with a few minor variations. Instead of the 1% rule, Freddie Mac will count just 0.5% of the student loan as your debt payment if you haven’t started repaying the student loan.

FHA loans and student loan payment

FHA loans are insured by the federal government and in general, have more flexible qualifying criteria. FHA borrowers can qualify for a 3.5% down payment on a mortgage with credit scores as low as 580, with debt ratio allowances above 50% in some cases.

However, when it comes to how they apply student loan payments, they are on the stricter side of the underwriting guideline spectrum.

Even if you have an income-based repayment, if the monthly amount you’re paying doesn’t fully satisfy the loan on time, FHA requires that the 1% rule be applied. If your payment is deferred, you’ll still need to qualify with 1% of your student loan balance as your monthly payment or you won’t be eligible for an FHA loan.

VA loans and and student loan payment

The Veterans Administration provides home loan benefits that allow eligible active duty and veteran servicemembers to obtain mortgages with no down payment. The VA home loan program also does not have a minimum credit score requirement.

Although the suggested debt ratio maximum is 41%, the VA doesn’t rely on this number to make a final determination on whether a servicemember qualifies for VA financing. Instead, the VA looks at how much the veteran and his family will have left over every month after deducting monthly housing expenses — a calculation called residual income.  As long as the residual income meets the guidelines based on the veteran’s family size, the 41% DTI can be overridden.

The VA approaches student loan debt a little differently from FHA and conventional loan programs.

If a student loan payment will be deferred for more than a year, no monthly payment is counted toward qualifying for a mortgage. If repayment begins in less than a year, the VA counts 5% of the student loan balance as a year’s debt — so you have to divide by 12 to get the monthly qualifying debt level. If you have a $100,000 student loan balance, you’d take 5% of that ($5,000) and divide it by 12 to get a monthly payment of $416.67 for qualifying.

This is significantly better than using 1% of the balance, which would be $1,000 per month, and even lower than Freddie Mac’s 0.5% rule.

Like the FHA, the VA doesn’t allow the use of an income based repayment plan to qualify, unless that payment will fully pay off the loan on time.  This is where your paperwork comes in handy — if you can’t verify the lower monthly payment with student loan paperwork, you’ll be stuck qualifying with the higher minimum payment calculation of 1%.

USDA loans and student loan payment

USDA loans are designed to help low- and moderate-income borrowers in rural areas of the country. USDA loans follow the same rules as FHA loans for student loan repayment qualifying.


Qualifying for a mortgage as a student loan co-signer

It’s frustrating to apply for a mortgage and then find out you don’t qualify because you have too much student loan debt — especially if you’re not even a student.

Recent guidelines have eased for people who co-signed on a loan for a student to go to college.

Since 2004, student loan debt among people aged 60 years and older has grown the fastest of any age group, with parents and grandparents tripling the amount of student loans they took on to help a child or grandchild.

If you plan to take out a mortgage for purchase or refinance now or in the next year, all mortgage programs now allow you to show proof of a year’s worth of payments on the student loan to keep from being penalized.

In order to make sure that the other party is making good on their student debt obligation, you’ll need to get proof that they have made the payment on their own, on time and from an account that is only in their name. If you are giving them cash for the payments, that won’t work, and the payment will be counted fully against you for qualifying purposes.

Either 12 months of canceled checks or 12 months of bank statement showing the payments coming from the primary borrower’s account will be acceptable.

Qualifying for a mortgage if your student loans are in default

If your student loans are in default, you won’t be able to qualify for a traditional mortgage until you work out an agreement to pay the debt off. The best place to start is to negotiate a trial payment schedule for one to three months.

Keep the documentation related to the payments, such as canceled checks or bank statements, and any letters verifying the payment arrangement. While not all lenders will allow this flexibility, it is the same guideline used to allow for approvals on borrowers who negotiate monthly payment arrangements on federal tax liens.

It’s better to enter into some sort of income based repayment schedule than default, and risk not being able to get a mortgage to purchase a home in the future.

Final thoughts

The best way to qualify for a mortgage with student loans is to minimize the amount of student debt you take out.

There are a lot of student loan debt consolidation options out there, but be sure you’ve completed the process before you start applying for mortgages, as it may take a few months for the consolidation to show up on your credit report.  If you do have student loan balances, try to keep your other debt to a minimum, so your student loan payments don’t have as much of an impact on your ability to qualify for a mortgage loan in the future.

 

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