When applying for a mortgage to buy a home, it’s important to know how or if deferred student loan debt, even if it’s in forbearance, can impact how much loan you will qualify for.
Unfortunately, there is a lot of outdated or misinformation on the Internet by ‘financial experts’ and even from mortgage loan officers about how various home loan programs treat deferred student loan when applying for a mortgage.
SCARY FACT: U.S. student loan debt is about $1.2 trillion dollars among 40 million people and tripled over the last 10 years. This is one major reason home ownership rates have fallen to 48 year lows.
Mortgage lenders are very concerned because monthly payments on student loan debt will nearly double in the future, which effects a borrowers ability to repay their mortgage loan.
Student Loan Debt Effects Your Buying Power
Student loan debt, whether it’s in deferment/forbearance or not, affects home buyers purchasing power because of the significant repayment amount.
Student loan debt is the same as any other liability. It is reported to the credit bureaus and the monthly repayment amount impacts a borrowers debt-to-income ratio and reduces how much loan a home buyer or borrower can qualify for.
Homebuyers with student loan debt planning to use Conventional (Fannie Mae/Freddie Mac) financing may qualify for even less than those who are using FHA financing because the Conventional DTI ratio cap is now 45%.
And the new QM/ATR govt. regulations our government recently passed will soon be reducing the maximum DTI ratio down to 43% and thus reduce your buying power even more! (so buy now rather than later)
How Much Can Student Loan Debt Reduce Qualifying?
Borrowers with $50,000 in student loan debt in the repayment phase can reduce a buyers purchasing power by up to $60,000 to $80,000! Or think of it this way, every $250/month in student loan payments will reduce a buyers purchasing power (loan amount) by about $40,000!
Fortunately, buyers with student loans can still use FHA financing because FHA allows buyers to go up to 50%-55% DTI ratio.
Deferred Student Loans Can Actually Hurt Credit Scores
Student loans in repayment phase builds positive credit history, but deferred student loan debt can have the opposite effect. Deferred (or in forbearance) student loan debt grows in size from deferring interest, will cause the balance to exceed the original loan amount…..that’s a credit score killer.
The FICO scoring formula will penalize your credit score because you owe more than you initially borrowed…..this is similar as if you are exceeding your credit limit on a revolving credit card….it’s a signal that a borrower is in financial distress.
If needing higher credit scores, you may want to consider paying down the student loan balance so that it doesn’t exceed the original loan limit. But don’t do this without consulting your loan officer (me if you are in California).
Mortgage Guidelines for Deferred Student Loans
Qualifying guidelines do not vary from lender to lender. Lenders don’t arbitrarily make up their own rules. ALL lenders must enforce and comply with the same guidelines set forth by Fannie Mae, Freddie Mac, FHA, VA, and USDA.
The reason you read about or hear different guidelines is that many people don’t actually know what the guidelines are…..so they give wrong or outdated advice.
Conventional Financing & Deferred Student Loans
If no monthly payment is reporting on the credit report, and you cannot document what the repayment amount will be, ALL lenders must use a minimum 2% of the student loan as the repayment amount. It’s even been reported that some lenders are going way overboard and now using 5% for a repayment amount to reduce borrower risk of default, which limits qualifying amount even more!
FHA Guidelines for Deferred Student Loans
FHA just announced that starting June 15, 2015, they will no longer exclude or omit deferred student loan repayment amounts from a borrowers DTI.
It doesn’t matter how long those student loans are deferred or in forbearance…..this goes for all forms of deferred obligations.
For student loans that do not report a payment on a borrowers credit report, they must use 1% of the loan balance.
Loans that are reporting an Income Based Repayment (IBR) payment plan must also use 1% of the loan balance for qualifying. Putting your student loan debt into an IBR repayment plan will NO LONGER HELP buyers qualify for a larger loan when using FHA financing.
I suspect this will have a far larger reaching effect on Millennials and the many other first time homebuyers we are all hoping will step up and start buying homes.
VA Guidelines for Deferred Student Loans
Government insured VA mortgage loans, for now, will still omit student loan repayment amounts from your DTI ratio if you can document the student loan debt is or will be deferred for a minimum of 12 months after the time your mortgage loan funds.
Be careful though. You need to make sure you can defer your student loan and that you don’t defer it too early, which would cause it to be deferred for less than 12 months from when your loan funds.
VA loans will allow a borrower to use the IBR payment when qualifying.
USDA Home Loans & Deferred Student Loans
USDA requires all deferred student loan repayments be included in the DTI ratio regardless of the term, but does allow just 1% of the student loan balance to be used for repayment and DTI ratio calculation.
If not in deferment, payments must be determined by documentation other than the credit report…such as a letter from the servicer or from a payment coupon.
For loans in an IBR or a Graduated repayment plan, USDA has specific requirements…call me for details.
Your Spouses Student Loans May Get Your Home Loan Denied
You would be shocked at how many people get their loan denied during escrow because the loan officer is not aware that in community property states (like California), the non-borrowing spouse’s student loan debt (and other debts) are factored into the borrowers liabilities and DTI ratio. Happens every day.
Should You Pay Off Student Loan Debt or Save for a Larger Down Payment?
Would it be more beneficial for you to pay off or pay down your student loan debt or save up for a larger down payment? Or maybe save money to pay closing costs?
That’s a good question that can only be determined by knowing what your current financial situation is and where you want to purchase.
Perhaps you can qualify for a first time homebuyer down payment or closing assistance program? Fortunately, my mortgage bank is approved to offer more homebuyer assistance programs than any other bank that I’m aware of and can help you determine which program you may be eligible for.
Options to Help Qualify for a Larger Loan
- Use FHA financing (allows higher DTI ratios)
- Get student loans deferred or in forbearance
- Consolidate student loans into one lower payment
- Magically come up with a larger down payment (gift money)
- Bring on a non-occupied co-borrower
- Pay off/down debt
- Use a Mortgage Credit Certificate (MCC)
Know Your Options & Get the Facts
It’s important to know all of your options and work with an experienced mortgage lender when it comes to financing and buying a home. Don’t get burned by the many smooth talking lenders who really don’t have the experience, knowledge, or loan programs you need to make the best home buying decision. Contact me here or call (951) 215-6119 to discuss your situation and get the facts.