Recent POLICIES May Help
Recent policy tweaks from Fannie Mae increase the odds of home ownership for those borrowers burdened by student debt. It’s all about debt-to-income ratios which we will explain below. Most borrowers with student loan debt have monthly payments on student loans that make qualifying for a mortgage a challenge. On top of that, there is a reluctance among those borrowers to add even more debt to what they may currently owe.
It’s true, if you are at the edge of qualifying, you may want to think twice before increasing debt. The revised programs are not right for everyone. Homes all require repairs, taxes, etc., that must be considered before embarking on the purchase of a new or existing home.
With those cautions in mind, read on to consider if you might be a fit for the new approach.
Most mortgages are owned by Fannie Mae. Fannie Mae buys mortgages from lenders, so lenders keep money on hand to continue lending. Were you to obtain a mortgage, it would be sold similarly, and your monthly payment would be managed by a third party.
Calculating the Debt-to-Income Ratio
Fannie Mae adjusted its debt-to-income ratio from 45 percent to 50 percent for all borrowers, so qualifying for a mortgage recently got easier with Fannie Mae. Freddie Mac has used the 50 percent mark for years but does fewer loans than Fannie Mae, so this change broadens borrowers access to these loans.
Here’s how it would work:
- Under a 45 percent debt-to-income limit, a person earning $7,000 a month with $300 in other debt and with enough cash for a 10 percent down payment could qualify to buy a $480,000 home.
- Under a 50 percent debt-to-income limit, that same person could buy a $540,000 home.
Effective July 2017, if your debt—student loans, car payments, or credit card balances—is being paid by others, it won’t count in your debt calculation. However, you’ll have to prove someone else is paying your debt by showing 1-year of canceled checks. Again, if a family member or employer is paying off your student loan, the debt will not count in evaluating your eligibility for a mortgage.
Lower Loan Payment
Formerly, Fannie Mae required lenders to count student loan debt as 1 percent of the loan balance, regardless of whether that percentage was accurate. Now, lenders are permitted to use the actual student-loan payment, which may be lower than the 1 percent calculation—particularly helpful to those borrowers whose payments are tied to income, rather than the standard 10- or 25-year repayment plan. Those programs are called Income-Based Repayment (IBR) or Income-Driven Repayment (IDR).
We will run a credit report on the student to determine the payment. If the credit report does not provide a monthly payment for the student loan, or if the credit report shows $0 as the monthly payment, we must determine the qualifying monthly payment using one of the options below.
- If you are on an income-driven payment plan, and we can obtain student loan documentation to verify the actual monthly payment is $0, then we can use a $0 payment to calculate debt-to-income.
- For deferred loans, according to Fannie Mae we may calculate
- a payment equal to 1 percent of the outstanding student loan balance (even if this amount is lower than the actual fully amortizing payment), or
- a fully amortizing payment using the documented loan repayment terms.
You or Yours Own a Home?
The first question should be whether you can refinance your student debt along with an existing home to get a lower interest rate (student loan rates are higher than mortgage rates). Fannie Mae offers a lower rate to these borrowers by eliminating the usual fees lenders charge for cash-out refinances. The total student debt is added to the mortgage amount being refinanced. Anybody—parent, grandparent—can take advantage of this program, using the rules above to calculate debt, so long as the cash received from the refinancing is used to pay off a student loan IN FULL.
If you do use a mortgage refinance to pay off a student loan, you forego the ability to pay off debt according to income and/or to pause payments. Furthermore, your home becomes collateral for the debt and can be seized if you default on payments. However, if you are looking for a better interest rate and are willing to give up these program protections, you should pursue a mortgage.
Freddie Mac does not currently permit lending to borrowers who have deferred student loan debt. If you are still in school and not making student-loan payments, the loan should still turn up on your credit report. In this case, Freddie Mac requires documentation of the loan.
Examples of documentation of the required payment amount include:
- Payment listed on a current credit report.
- A statement from the student loan lender stating what the payment will be in the future; or
- A copy of the installment loan agreement; or
- If no other documentation can be obtained showing what your future payments would be, the lender must use 1 percent of the loan balance as the monthly payment for qualifying purposes.
Freddie Mac still uses the 1 percent calculation:
- 1 percent of the outstanding balance (which is almost always higher than the IBR payments).
- The actual standard plan repayment amount reported on the credit report (this is the most common method lenders choose because it’s the easiest). Remember, your credit report will always show your standard 10-year amount for “Amount Due,” not the amount you actually pay.
- A calculated payment that will fully amortize the loan over the repayment period (this means that you must calculate a payment with no forgiveness after 20/25 years). This could be equal to your IBR payment or higher.
This rule is what makes getting a mortgage from Freddie Mac a challenge.
Down Payment Requirements
Down payments have decreased with Fannie and Freddie both offering programs with as low as 3 percent down. FHA is both more forgiving of debt and offers 3.5 percent down.
How to Get Monthly Amortized Payment From Student Loan Provider
Borrowers with large balances on their Deferred Student Loans can have issues when qualifying for an FHA Loan. If we take a loan case scenario where a borrower has $100,000 in deferred student loans and go over this scenario on how to make it work. Here is how a loan officer should qualify such a borrower
- If you have $100,000 deferred student loan balance.
- 1 percent of this will be $1,000 per month under option #1.
- However, getting a proposed amortized monthly payment by the student loan provider will get this figure down to about $500 per month.
- The borrower needs to contact the student loan provider and tell the representative that they are applying for a mortgage.
- The loan officer can be on a three-way conference call with the borrower and student loan provider representative.
- The borrower needs a fully amortized monthly payment amount if the deferred student loans were out of deferment over an extended payment plan which is normally 25 years.
- Remember that it needs to be fully amortized and cannot be an income based repayment plan or IBR.
- This figure should be around 0.5 percent of the outstanding student loan balance which is around $500 on a $100,000 balance student loan amount.
- The loan officer can take the figure that was given over the phone and use that amount as the borrower’s monthly debt when calculating the borrower’s debt to income ratio.
- The lender will need a letter confirming the monthly amortized amount which may take a day or two for the student loan provider to send to the borrower.
Qualify for a Veteran’s Administration (VA) Loan?
If you are a veteran or if your student loan provider provides written evidence that the student loan debt will be DEFERRED at least 12 months beyond the date of closing, a monthly payment does not need to be considered.
If a student loan is in repayment or scheduled to begin within 12 months from the date of VA loan closing, the lender must consider the anticipated monthly obligation in the loan analysis and use the payment established in paragraph (1) or (2) below.
Calculate each loan at a rate of 5 percent of the outstanding balance divided by 12 months (example: $25,000 student loan balance x 5% = $1,250 divided by 12 months = $104.17 per month is the monthly payment for debt ratio purposes).
- The lender must use the payment(s) reported on the credit report for each student loan(s) if the reported payment is greater than the threshold payment calculation above.
- If the payment reported on the credit report is less than the threshold payment calculation above, the loan file must contain a statement from the student loan provider that reflects the actual loan terms and payment information for each student loan(s). The statement(s) must be dated within 60 days of VA loan closing and maybe an electronic copy from the student loan provider’s website or a printed statement provided by the student loan provider. It is the lender’s discretion as to whether the credit report should be supplemented with this information.
Okay, it is rather complicated, but our loan officers are trained to figure it out for you. Just give us a call if you are interested in a home purchase and happen to still have student loan debt!