Many people report that their student loan debt is the primary reason that they’ve delayed buying a home. In fact, 71% of young adults who have student loans cite this reason. Now several changes at the Federal Housing Authority may change that!
Fannie Mae, which was created in 1938 to give banks the needed funds to offer mortgages, announced changes last week that affect its underwriting requirements as they apply to consumers with student loans. Previously, borrowers who used an income-driven repayment plan for their student loans were unable to use the lower payments when their lender calculated the debt-to-income ratio. Typically mortgage lenders require a monthly debt-to-income ratio no higher than 43-50 percent. The lender was required to use 1 percent of the loan balance rather than the borrower’s actual payment amount. Under the new underwriting standards, lenders can use the existing payment, larger than zero.
For example, a borrower with $60,000 in federal student loans, an adjusted gross income of $50,000, and a family size of three would have a payment under the REPAYE program, one of the several income-driven plans available, of approximately $161. If required to use 1 percent of the balance in the mortgage calculation rather than the actual payment, the amount would be approximately $600. This difference can be what decides if the borrower qualifies for a mortgage or doesn’t.
The new standards come with cautions: the payment amount must appear on the borrower’s credit report and must be more than zero. If not, the 1 percent rule is required. Otherwise, the borrower may apply for a new income-driven plan that will pay off the loan in full during the term. Borrowers may consult with their lender about other plans, such as consolidation, extended, and graduated repayment plans.
Potential home buyers should keep in mind that credit reports may take a month or longer to display activity; those planning to apply for a mortgage should get their payment plans in place a few months ahead of starting the mortgage application process. This will allow time to confirm that their payments are evidenced on their credit report.
As employers acknowledge the value of offering student loan repayment as an employee benefit, Fannie Mae rules now allow lenders to exclude third party payments from the mortgage calculation as long as the borrower has documentation that an employer or parent has satisfactorily made payments for at least the last 12 months.
Lastly, private student loan borrowers may be more pleased with one new rule than most federal student loan borrowers. A new rule allows those borrowers with sufficient equity in their home to refinance their mortgage to include funds to repay some or all of their student loan debt. Cash-out options have always been an option for borrowers with home equity, but cash amounts in excess of the actual mortgage amount were usually charged fees and often a higher interest rate than the mortgage itself. However, the new rules allow the same rate on the amount of student loan pay-off as for the new mortgage. Certain rules apply. The borrower is not required to pay off all existing student loans, but at least one loan must be paid in full in the transaction. Pay-off amounts will be sent directly to the student loan holder, and only loans for which the mortgage borrower is personally responsible may be paid.
When considering refinancing, keep in mind that mortgage interest rates are generally lower than most private student loan rates and many parent PLUS and graduate PLUS loans, but they may not be lower than the rates for federal Perkins and Stafford loans. It’s important to do your research ahead of your refinance. In general, it’s good to keep the long-term implications in mind since paying off federal loans may mean losing the lower payment, deferment, and discharge options that such loans maintain.