You want to buy a house. But you have massive student loan debt. So you automatically think: “I can’t get a home loan because of my student loans.”
But here’s the thing: you’re likely wrong.
Although you may have some difficulties, getting a mortgage with student loan debt is possible. And that's especially true if your loans are federal student loans from the U.S. Department of Education.
True, a recent study by the Federal Reserve Bank of New York shows that homeownership by people under the age of 35 has decreased while borrowing for student loans has increased.
But that doesn’t have to be true for you.
You can buy a home with student debt. You just might not be able to get the home of your dreams, at least not right now. And that’s especially true if:
- your student loan debt to income ratio is high
- your credit score is less than 650 and
- you have little to no down payment.
If those things are true for you, keep reading.
Let’s start with the basics.
Student Loan Debt to Income Ratio
Do student loans affect debt to income ratio? Of course.
Your student loans are a monthly debt obligation that (theoretically) needs to be repaid at some point.
Because of that need, your lender will factor your student loan payment amount into your overall monthly debt.
And that number will be compared against your gross income to determine your DTI ratio. (Your DTI ratio is your monthly debt payments compared to your income.)
FYI, a DTI below 20% is considered excellent.
Now that we’re clearer about student loan debt and its effect on your debt-to-income ratio let’s discuss…
High student loan debt and buying a house with little to no down payment
Graduating with massive student loan debt, especially when you have an advanced degree, has become the new normal. Got a masters? A JD? An MD? You likely owe well over a $100 thousand in student loans like the client in this video who I recently helped get his student loans together so he could buy his first home.
In today’s economy, although people assume otherwise, that high student loan debt is not matched by a high income. Instead, you likely have a salary that isn’t much different from those without an advanced degree. At least starting off.
- Why Does My Spouse Have to Sign My Income-Driven Repayment Plan Request Form
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Still, you want your piece of the American dream. Marriage. Family. Home.
So what to do?
You could wait. Scrape. Save. Pay down debt. Live below your means. Eat out less. Work more. Craigslist everything nonessential. Embrace minimalism.
But where’s the fun in that?
You want a home now. But you don’t have a lot of savings. And you’re tired of giving money to a landlord.
In that situation, here’s what you’re likely going to do:
You’ll get a mortgage from one of those programs because, unlike other conventional loans, they help first-time home buyers buy a home with a minimal (or zero) down payment.
Each program offers different types of mortgage products that each have their own loan application requirements for mortgage approvals. But for the most part, the basic requirement is that you have a source of income and a minimum credit score.
Because my focus is on buying a home with student loan debt, I’ll skip discussing each program’s acceptable DTI and minimum credit score.
FHA Guidelines for Getting a Mortgage with Student Loans
The FHA student loan guidelines provide that your lender must include all of your student loans in your liabilities. And that’s true no matter the payment type or status of payments.
With an FHA backed loan, your lender will use your actual documented payment (if it pays off the loan over the payment period) OR the greater of:
- 1% of your outstanding balance on the loan; or
- the monthly payment reported on your credit report.
So what does that mean to you?
Basically, your monthly payment under an income-driven repayment plan is likely no help to you for an FHA mortgage.
- Yet Another Way Student Debt Keeps People From Buying Homes, The Atlantic
- Now It May Be Even Easier to Buy a Home With Student Loans, Market Watch
Here’s an example.
Let’s say you owe $100 thousand in student loans and your monthly minimum payment under the Revised Pay As You Earn plan is $300. In this case, your FHA lender has to use $1 thousand as your assumed monthly student loan repayment. That number can kill your DTI ratio.
What you may consider doing in this situation is exiting your income-driven repayment plan to move into either a Graduated repayment plan or an Extended Fixed or Extended Graduated repayment plan.
Either one of those plans will give you a monthly payment that’s higher than your IDR payment but much lower than your imputed payment under the 1% rule.
Once you’re approved for the FHA loan, there’s likely nothing stopping you from switching back to your income-driven repayment plan and getting that lower payment.
But What About FHA Student Loan Deferment
The FHA guidelines treat deferments the same as they do income-based repayment plans.
So, regardless of whether you're in deferment, forbearance, or under an income-driven repayment plan, the FHA guidelines provide that your lender must use either:
- the greater of 1% of the outstanding loan balance or the monthly payment reported on you credit report; or
- the actual documented payment but only if that payment will payoff the loan over its repayment term.
Let's give an example. You owe $100 thousand in student loans. You're in the PAYE plan and your payment is $200. That number shows on your credit report. Your payment under the PAYE plan will not payoff the loan over its repayment term. What number do the FHA student loan guidelines demand be used for student loan debt-to-income ratio? $1,000.
Fannie Mae Guidelines for Getting a Mortgage with Student Loans
Fannie Mae is a little bit more flexible than the FHA when it comes to student loans. With Fannie Mae, according to B406-05 regarding Monthly Debt Obligations, your lender can use the actual payment listed on your credit report even if it says $0.
But if a student loan payment isn’t listed on your credit report (and if it says $0) then your lender has to get documentation of your payment (that includes a $0 payment). And if you’re not in repayment (because you’re in deferment or forbearance), your lender has to use either:
- a payment equal to 1% of your overall student loan balance; or
- a payment that amortizes the loan under the documented repayment terms.
Long story short, with a Fannie Mae mortgage, deferment or forbearance is typically not what you want to do with your student loans. You want to be in a documented repayment plan, preferably one based on your income.
Click here to learn about IHDA SmartBuy Home Buy Program in Illinois
Freddie Mac Student Loan Guidelines
Freddie Mac, unlike Fannie Mae, will not use a $0 payment or a deferment or forbearance on your student loans.
Instead, Freddie Mac will use a monthly payment of 0.5% of your outstanding balance. For example, if your balance is $100 thousand, then your monthly payment for DTI purposes would be $500.
But what if your payment under an IDR plan is greater than $0?
There, Freddie Mac will use the amount reported on your credit report or other acceptable documentation.
Getting a VA Mortgage Loan with Student Loan Debt
You know how I mentioned that with a Fannie Mae mortgage you want to avoid deferments or forbearances? With VA mortgages, when it comes to DTI, deferments and forbearances are a good thing.
According to Circular 26-17-02, Clarification and New Policy for Student Loan Debts and Obligations, the VA will not count your student loan payment in your DTI if your loans are in deferment or forbearance for 12 months beyond the closing date.
But what about income-driven repayment plans?
In that case, you’re still good --- if the payment is listed on your credit report.
So long as your IDR payment is listed on your credit report, the VA lender can use a statement from your servicer that reflects the payment information for each loan. The statements must be within 60 days of the VA loan closing. You can use an electronic copy from your servicer’s website or a statement from the servicer.
And if your payment is listed on your credit report? The lender must calculate each loan at a rate of 5% of the outstanding balance divided by 12 months. If you have a high student loan balance, you want your loan payments listed on your credit report or else ☠️☠️☠️.
Buying a House with Student Loans in Deferment
As I mentioned above, if your loans are in deferment or forbearance, a mortgage from Fannie Mae or the VA is your best bet. Both programs won’t include your student loans in your debt-to-income ratio if your loans are in deferment or forbearance.
But the FHA? They will ignore the deferment or forbearance to calculate your monthly payment based on 1% of your overall balance.
Final Thoughts About Student Loans and Mortgages
High student loan debt does not have to stop you from getting a home. Sure, it may make things more difficult for you. But difficult does not mean impossible.
There are many programs each with its own guidelines for calculating debt-to-income ratio when your student loans are in an income-driven repayment plan or in deferment or forbearance.