Student Loan Debt Doesn’t Have To Derail You Home Buying Plans
Got Student Debt? You Can Still Realize Homeownership.
September 27, 2019
With student loans preventing scores of people from buying homes and saving for retirement, the government has stepped in to help.
Student loan debt has long been the scourge of millions. At last count, the United States collectively owes $1.5 trillion, with the average person staring down a more than $30,000 bill.
Those student loans can seem crushing, threatening to prevent people from reaching financial goals such as purchasing a home or saving for retirement.
But student loan debt doesn’t have to sideline your dreams of homeownership. Thanks to rules implemented in recent years by Freddie Mac and Fannie Mae, the government-backed mortgage lenders, it’s become a little easier to have both.
It's all about the DTI
When it comes to qualifying for a mortgage, lenders look at several factors including your debt-to-income ratio. Your debt-to-income ratio (DTI) is presented as a percentage and compares your monthly debt payment to your monthly gross income. The higher your DTI, the less attractive you look in the eyes of mortgage lenders. They use that ratio to gauge how likely you are going to be able to pay back your mortgage.
Student debt is included when determining a borrower’s DTI and is one of the reasons people are turned down for a mortgage.
When it comes to calculating the DTI, the type of debt also matters. You may owe $10,000 on a credit card, but only have a minimum monthly payment of $50. Lenders will use that payment, not the total debt, when calculating your DTI. But that’s not true of student loans. Lenders have two options: use a monthly payment that would make the loan good in a certain time frame or take 1% of the loan balance. It doesn't matter if the borrower is on an income-driven repayment plan that can lower the payment each month. Income-driven repayment plans are offered by the government, enabling student debt holders to pay back only what they can afford based on their income and family size. A repayment plan such as this could result in the borrower paying nothing each month or as little as $50. These plans are geared toward people with low income and high debt.
Fannie Mae, Freddie Mac relax DTI guidelines
Fannie Mae and Freddie Mac overhauled DTI guidelines recently, allowing borrowers to use their actual monthly payment to calculate DTI. Under the new guidelines, if the student loan payment is more than $1, lenders can use the monthly payment. If the payment is $0 on the credit report, lenders have to take 0.5% of the outstanding balance, down from 1.0%, and use that to calculate the DTI. Borrowers in the first category benefit the most. They may have $50,000 in student debt but with a $1 payment due each month, only $1 is included in the DTI. A borrower that pays nothing monthly will see a bigger hit to his or her DTI since the lender has to consider 0.5% of the loan balance.
In addition to overhauling the guidelines, Fannie Mae has its HomeReady program which allows a down payment of just 3%, a maximum DTI of 50%, and the ability for other people to contribute to the loan. Family or friends can co-sign the loan and income for members of the household can be counted toward the eligibility requirements. Unlike other government-backed mortgages, borrowers can cancel the required mortgage insurance once the equity in their home reaches 20%. Freddie Mac’s HomeOne mortgage offers similar requirements with no income limit or maximum DTI.
Boost your income, slash your debt
Outside of Fannie Mae and Freddie Mac, there are ways to improve your chances of getting a mortgage when you’re saddled with student loan debt. If your DTI is still high, boosting your income via a raise or side gig can help. Refinancing your student loan debt into a lower interest rate or extending the loan terms can also improve your DTI if it lowers your payment. Keep in mind that if you extend the terms of your loan, you’ll end up paying more in interest.
The cost of a college education has skyrocketed over the decades with students today paying more than double what their parents did. That means more people will be swimming in debt. But that doesn’t mean homeownership is out of their grasp. By taking advantage of government programs like the income-driven repayment plans and keeping DTI low, student loan debt doesn’t have to stand in the way of your dream of homeownership.