Deferred student loan debt can have a very large impact on a buyer when applying for a mortgage.
Unfortunately, there is a lot of outdated or misinformation on the Internet by ‘financial experts’ and even from mortgage loan officers about how various home loan programs factor or calculate student loans that are forbearance or deferred 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 deferred 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, affects a home buyers purchasing power because of how the mortgage guidelines calculate a repayment amount in the borrowers DTI ratio.
Student loan debt is the same as any other liability. It’s 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 deferred 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 Conventional loans have a DTI ratio cap of 45%.
And the recently passed QM/ATR govt. regulations our government 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 Deferred 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 qualify for more when using FHA financing because FHA allows DTI ratios to go up to 56% 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…..and 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
At a minimum, ALL mortgage lenders must enforce and comply with the same guidelines set forth by Fannie Mae, Freddie Mac, FHA, VA, and USDA. Lenders cannot just make up their own guidelines to make qualifying easier because they are heavily regulated by the federal government.
The are really only two reasons there would ever be conflicting information regarding what the actual qualifying guidelines are in regards to deferred student loan debt.
- The loan officer is clueless and doesn’t stay up to date on the never-ending guideline changes
- The loan officers lender applies an ‘overlay’ or more restrictive guideline that makes qualifying more difficult
==> Conventional Financing & Deferred Student Loan Rules
Conventional financing is a term used to describe financing that meets federal agencies Fannie Mae and Freddie Mac. Both Fannie and Freddie are the agencies who create the guidelines that all lenders must confirm to when approving a Conventional conforming loan.
==> Fannie Mae Deferred Student Loan Guidelines
A payment of 1% of the balance must be used for repayment or confirm what the actual payment will be when no longer in deferment or calculate a fully amortized payment.
==> Freddie Mac Deferred Student Loan Guidelines
For student loans in deferment or in forbearance, Freddie Mac has different requirement based on whether a payment reports on credit or not.
No Payment Reporting – With a $0 payment reporting, lenders must count .5% of the outstanding balance as a repayment amount.
With Payment Reporting – If the payment is greater than $0, even if it’s just $1 reporting on credit, Freddie Mac will accept that as a repayment amount.
For student loans in a deferment or forbearance that are part of a student loan forgiveness, cancellation, or employment contingent repayment plan (often called the PSF plan – Public Service Loan Forgiveness plan), the student loan payment may be excluded from the monthly DTI ratio if you have less than 10 months remaining …..contact me for details.
==> 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 deferrd student loans that do not report a payment on a borrowers credit report, they must use 1% of the loan balance as a reapyment amount when calculating DTI ratios.
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 greater impact on Millennials and the many other first time homebuyers we are planning to purchase homes.
==> VA Guidelines for Deferred Student Loans
Government insured VA mortgage loans, for now, will still allow lenders to 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.
USDA Home Loans & Deferred Student Loans
When student loans are deferred, USDA requires .5% of the student loan balance count as a monthly repayment amount when calculating the DTI ratio.
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.
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.