Student loan debt by itself is a significant issue in America. When a borrower with student loans is ready to purchase a home, things get challenging.
One challenge: The low income driven payment will not factor into the qualification. Instead, a more significant 1% of the balance may be used causing an insurmountable “calculated” student debt payment.
A recent online Money article states, “Of the more than 40 million Americans who have student debt, 5.9 million – about 14% of the total group – owe more than $50,000.”
Jumbo Student Loans
The growing group of high student loan balances or “jumbo student loans” has been created by rising college costs, improved access to loans, plus income-based plans that require zero to low payments that don’t pay down the balance.
This becomes a problem with mortgage lending when a guideline requires 1% of the balance to be used in qualifying a buyer. Imagine adding a $1,300 payment for owing $130,000 in student loan balances. There are not many buyers, especially younger buyers, who could qualify for a home with such a payment. Although, there are solutions which we will explain below.
VA Home Loans Provide Flexibility on Deferred or Income Based Payment Student Loans
Student loan payments are no stranger to service members, Veterans, or surviving spouses of military. Although the military has excellent programs to assist service members with financing education costs, rising university tuition may create a gap. Also, parents may cosign on student loans for their children which can also affect the parents’ home loan qualification. Luckily, VA is very flexible when it comes to qualifying with student loans. There are several variations that VA addresses in this area.
How Does VA Treat Deferred Student Loans
Deferred student loans require no payment for a period, and VA is currently the only loan that recognizes the deferred zero payment. VA will count zero for the minimum payment AS LONG AS the student loan(s) are deferred for greater than one year after the loan closing date. In this case, the VA loan borrower qualifies without using a payment for student loans. If the student loans are deferred for less than one year, then use the calculations for payments on Income-Driven Repayment.
How VA Treats Income Driven Payment Student Loans
Income-Driven Payment plans such as Income Based Repayment (IBR) are prevalent these days as they provide a way for many to afford the college debt within their current income level. Many lending programs will not use this lower payment, but VA has a unique calculation that works much better than the standard 1% calculation that FHA and USDA use as discussed later.
If a student loan is not deferred over 12 months after the closing date or the payments are income driven, VA requires lenders to use the higher of:
- Payment on the credit report
- 5% of the outstanding balance divided by 12 months
However, if the borrower can document that the credit report payment is the fully amortized payment, then using this payment would be allowed. In an example of a $50,000 student loan balance, a 1% payment would be $500 per month. Although, VA would use $208.33 which is $50,000 multiplied by 5% and divided by 12 months. Finally, if a payment is fixed for at least 12 months after closing, the fixed payment may be used.
How FHA Treats Income Driven Payment Student Loans
FHA is a very popular, low down payment, flexible mortgage loan program that has been in existence for a long time. It has also treated deferred or income-based repayment loans differently over time. Although FHA used to be very flexible in this area, it has become more conservative over the last few years.
FHA loans require that all student loans must be counted against a borrower regardless of deferment or not. Furthermore, FHA guidelines require lenders to calculate 1% of the balance listed on the credit report as a payment or the documented payment on the credit report, WHICHEVER IS HIGHER. Another alternative is to use the documented fully amortized payment. “Fully amortized” means using the full principal and interest payment based on the balance, rate, and term of the student loans. An experienced mortgage loan officer will help determine which calculation is most beneficial in each scenario.
As mentioned earlier, using 1% of a large balance could prove difficult to qualify for a home purchase. Although, FHA does allow for a co-borrower that doesn’t have to live in the home, as well as, higher debt to income thresholds which could help in qualification.
Conventional Loan Options for Borrowers With Student Loans
Conventional loans are divided between Fannie Mae and Freddie Mac loans. Although both are conventional financing, they vary at times in their guidelines. In student loans, this is also the case. Let’s break down a comparison for Fannie and Freddie using the different student debt payment types – non-deferred, deferred, and income-based repayment.
Non-deferred Student Loan Payments
Non-deferred payments mean that some level of payment is required at this time. Fannie Mae states if a payment is listed on the credit report, use that figure. If no payment is listed on credit, obtain documentation confirming the payment and use this figure. Freddie Mac requires using the payment listed on the credit report OR .5% of the outstanding balance, whichever is higher. Each scenario is different, so an OVM loan officer will determine which conventional loan is more beneficial.
Deferred Student Loans
Deferred student loans do not require payment at this time and have deferred payments to sometime in the future. In this case, Fannie Mae requires lenders to use 1% of the balance OR the documented fully amortized payment. Freddie Mac does the same, yet states the higher of the two calculations must be used.
Fannie Mae only has a guideline in this area currently, and that is Fannie will allow the use of this payment. As stated in the non-deferred section, a low payment on the credit report could just be used, but what if the payment is $0? As long as documentation is provided to prove that the actual required payment is $0, it may be used. If the $0 repayment terms expire in a few months, documentation may be required to prove at renewal it will also be $0.
Freddie Mac addresses one other common area. The guideline states the student loan does not need to be counted at all IF (all three must be met):
1) The loan has 10 or fewer payments remaining until the full balance is forgiven, canceled, or discharged or paid.
2) The monthly payment is deferred, and the total balance will be forgiven at the end of the forbearance period.
3) The borrower meets requirements for loan forgiveness, cancellation, discharge, as applicable and lender is not aware of any circumstances that will make the borrower ineligible in the future.
USDA Student Loan Payment Requirements
USDA loans are one of the most unknown, yet beneficial mortgage loans available to buyers today. Contrary to beliefs, it is not just for first-time buyers. Furthermore, it provides 100% financing, very low mortgage insurance, and flexibility on credit. USDA terms are typically better when compared to FHA assuming the borrower qualifies for both. Plus, new USDA income limits increase allows more families to buy with no money down. USDA home loans treat deferred and other variations of student loan payment plans like FHA.
USDA states that all student loans must be counted against the borrower regardless of deferment or not. To calculate the student loan payment, lenders must use 1% of the balance listed on the credit report as payment or the documented fully amortized payment. Therefore, lenders do not just go by the payment on the credit report. The loan officer will calculate debt ratio payments using one of these calculations.
State Housing Agency Requirements for Student Loans
State housing agencies include organizations such as NC Housing Finance Agency (NCHFA), Virginia Housing Development Authority (VHDA), or SC State Housing Finance and Development Authority. These agencies provide down payment assistance and other programs to promote homeownership. Each agency typically follows guidelines for each of the programs above. For example, if FHA is being used along with a VHDA assistance program, then FHA rules would be followed.
With well over $1 trillion in student loan debt across America, student loans play a massive role in homeownership. Plus, it doesn’t just affect millennials who are just out of school. It also plays a role in students who have gone back to school later in life as well as parents or grandparents who have cosigned for students. So, it is easy to see how buying a home could be tricky in these cases. Luckily, OVM Financial offers all of the above programs, and we will do our best to walk buyers through potential options to finance the home of their dreams.
Now, you know how buying a home with student loan debt works. Also, check out recent articles which help buyers prepare for their home purchase with credit prep: What Comes Before House Hunting Season? Credit Score Improvement Season & More Buyers Qualify During Tax Season – See Why