You have a massive amount of student loan debt, but you also want to buy a home. The good news is that student debt doesn't automatically stop you from becoming a homeowner. Chances are, if you can afford rent while repaying your student loans, you can afford monthly mortgage payments.
If you're looking to buy a home and think your student loan debts are an obstacle, this guide will help you navigate the process.
- FHA Loan Program: Tips on avoiding the 1% rule
- Keep IDR payments: Freddie Mac student loan guidelines
- Defaulted Student Loans: How to get off the CAIVRS list
FHA New Student Loan Guidelines 2021
Last week, the Federal Housing Administration (FHA) made it easier for people with student loans to buy a home by changing its student loan guidelines. Previously, FHA lenders would have to use 1% of a borrower's student loan debt regardless of their actual payment under an income-driven repayment plan.
The new FHA policy will allow mortgage lenders to use your actual monthly student loan payment amount. The one exception is if your monthly payment is $0 (which is possible under an income-driven repayment plan). In that case, the FHA lender will automatically apply 0.5% of the outstanding student loan balance as an assumed payment.
The start date of these new FHA student loan guidelines is August 16, 2021. However, your lender can start using the policies now.
How student loans affect the mortgage process
Student loans affect the mortgage process by increasing your debt-to-income ratio, making it difficult for you to save for a down payment, and potentially decreasing your credit score if you miss monthly student loan payments.
- Increase your DTI ratio. Borrowers with higher loan balances will have higher minimum monthly payment amounts due on their student loans. Higher monthly payment amounts will increase your monthly debt-to-income ratio percentage, which may limit the mortgage you're approved for. Federal student loan borrowers can decrease their DTI by entering into a repayment plan based on their income (e.g., IBR).
- Make it harder to save. Having to pay your student loans each month slows your efforts to improve your overall personal finances through saving. Of course, borrowers with federal student loans paying under a repayment plan based on their income may be able to save. But, depending on their loan balance, they'll often have difficulty qualifying for a mortgage if their lender doesn't accept their income-based repayment amount.
- Affect your credit score. While your student loan balance doesn't lower your score, missing a monthly payment will cause your credit score to plummet. And that's especially true if you miss a payment and you have multiple loans. Each loan will add negative information to your credit report.
Can student loans prevent you from buying a house?
Student loans can prevent you from buying a house if you default on a federal student loan. When you default on a federal loan, you're automatically placed in the CAIVRS system. So if you're applying for an FHA, VA, or USDA Loan, you must first clear that system. You do that by getting your federal loans out of default.
Also, your monthly student loan payments can make it difficult for mortgage lenders to approve your homeownership application. Each mortgage loan program has its own guidelines for including your student loan obligations into your overall DTI calculations. Some programs, like FHA Loans, won't accept payments under an income-based repayment plan.
How can I get a mortgage with high student loan debt?
You can maximize your chances of qualifying for a mortgage with high student loan debt if you:
- Raise your credit score
- Improve your DTI ratio
- Keep a steady job history
- Check out first-time home buyer programs
- Work with a good lender
- Refinance private student loan debt
- Get downpayment assistance
- Get a cosigner
1. Raise your credit score
Your credit score plays an outsized e role in your ability to get a mortgage with high-student loan debt. A higher score not only allows you to qualify for a lower down payment and a lower interest rate, but it also allows you to qualify for mortgage loans that limit the impact your student loans have on your DTI ratio (e.g., Fannie Mae and Freddie Mac backed conventional home loans).
Paying your student loans on time consistently and requesting forbearances when you can't is one thing you can do to increase your credit score. You should also:
- Pay bills on time. A single missed payment can crush your score. So before you miss a payment, ask for a deferment or forbearance. Suppose you already have late student loan payments on your credit report. In that case, you're going to find it near-impossible to get your student loan servicer to agree to remove the negative information from your credit report.
- Lower your credit utilization rate. Ideally, you'd want to use less than 30% of your available credit on each credit card you have.
- Avoid new credit lines. Stop applying for new credit within 1-2 years before buying a home.
- Keep old accounts open. Older accounts help raise your credit score. So avoid closing credit card accounts with zero balances.
Pro-tip. Tools like Credit Karma are great for monitoring changes to your credit report. But they're not great at providing a usable credit score. Be prepared for the credit score your lender has for you to be about 20 to 30 points less than your Credit Karma score (or your FICO score, for that matter.)
2. Improve your DTI ratio
There are two parts to DTI that you'll need to worry about, front-end and back-end.
The front-end ratio is your projected monthly mortgage payments divided by your gross monthly income (income before taxes). Your projected mortgage payment is your principal, interest payments, taxes, and insurance (PITI).
The front-end DTI ratio will depend on the lender.
But for conventional loans, you should expect a ratio of about 28%.
Federal Housing Administration Loans (FHA Loans) allow for a maximum front-end ratio of 31%.
The back-end ratio accounts for all of your debt obligations as compared to your income. Your lender will calculate this ratio by first adding your monthly debt payments to your housing expenses. Your monthly debt payments include child support, auto loan, credit card debt minimum payments, student loans, etc. Once your lender totals your monthly expenses, they'll divide it by your gross monthly income.
Many conventional lenders will set the back-end ratio at 36%. In most cases, FHA Loans allow for a back-end ratio of 43%. In exceptional circumstances, the maximum DTI they'll allow is 56.99%.
If you owe a massive amount of student loan debt, the higher front-end and back-end limits allowed for FHA Loans may make you think that's the type of mortgage you should pursue. But the FHA Guidelines won't accept your student loan payment if you're in an income-based repayment plan. The FHA program will calculate your DTI using either 1% of your student loan balance or monthly payment that amortizes (pays off) your loan balance.
Borrowers with high balances on their federal student loans who are repaying their debt under an income-driven repayment plan have a better chance of becoming a homeowner if they qualify for a conventional mortgage. Many conventional lenders will accept your monthly payment under an IDR plan.
3. Keep a steady job history
As part of your home loan application process, your lender will not only look at your front-end and back-end DTI ratios, credit report, assets, available down payment, and income, but they'll also look at your work history.
Many lenders will require two years of employment history from all income sources.
So if you're a recent college graduate, you may need to hold off on buying a home until you reach that two-year mark. The same is true if you've picked up a side-gig to increase your monthly income.
4. Work with a good lender
Not all lenders and mortgage brokers are created equal. Some are better than others when navigating the student loan guidelines under the different homeowner programs. Ideally, you'd want to work with a lender:
- who has recently helped borrowers with high student loan debt and moderate-income get into a home; and
- who looks to provide solutions to overcoming your student loan debt in the home buying process rather than leaving you to solve things yourself.
I wouldn't rely solely on my real estate agent to connect me with a lender. I'd check with my friends who recently bought a home that I know have student loan debt to see who they worked with and how their experience went.
Watch this interview with senior mortgage officer Dennis Tate to get an idea of what to look for in choosing your lender/mortgage broker.
5. Check out first-time home buyer programs
In addition to down payment assistance programs, you can also take advantage of one of the many first-time homebuyer mortgage programs offered by federal and state-based agencies. These programs offer low interest rates, and many have no down payment requirement, which can be a huge boost if you're dealing with a heavy student loan burden.
- VA Loans: no down payment required. Open to military members and veterans.
- USDA Loans: no down payment required. Open to home buyers willing to live in rural areas.
- Good Neighbor Next Door Program: down payment as low as $100. Open to teachers, police officers, firefighters, and EMTs.
States have created first-time home buyer programs and downpayment assistance offerings for their residents. Many of these programs help with closing costs and other expenses.
In addition, there are also state-backed loan programs that help eligible participants lower their interest rate and monthly payment, both of which can save you money over the life of the mortgage.
The Department of Housing and Urban Development (HUD) maintains a list of state-specific resources at HUD.gov.
6. Refinance private student loan debt
If your private student loans have a high-interest rate and short repayment period (10 years or less), refinancing into a new loan lower interest rate and longer repayment term may help lower your DTI.
Refinancing federal student loan debt is also an option. But if you work for the government or a nonprofit and are pursuing the Public Service Loan Forgiveness Program, refinancing may not be in your best interest. You'd lose eligibility for the PSLF Program.
You can check student loan refinancing options at credible.com
7. Get down payment assistance
While a down payment of 20% of the purchase price is great (you can avoid private mortgage insurance (PMI)), that's likely not going to be your story. Don't worry. You're not alone.
Many first-time home buyers with student loan debt haven't been able to save for a significant down payment. They've only recently begun earning more income, and they've been paying back their student loan debt.
Thankfully, many down payment assistance programs help cover both the down payment and closing costs on your loan.
The assistance will usually be:
- A down payment grant. Grants are interest-free and don't need to be repaid.
- Forgivable second mortgages. Second mortgages can be forgivable loans on top of the one used to finance your house. They're forgiven if you live in the home for a certain number of years.
- Traditional second mortgage. A second mortgage can give you assistance via a low-interest loan. This loan will need to be paid off monthly, just as your primary mortgage does.
- Matched savings programs. A matched savings program requires saving funds in a dedicated down payment savings account. The entity offering the program will match those funds up to a certain amount.
These programs typically aren't open to everyone. You have to meet specific eligibility requirements. You may need to:
- be a first-time home buyer
- have income below a certain amount
- serve in the military or be a veteran
- work in public service (e.g., teacher, police officer, firefighter, etc.)
- complete a homebuyer education course (e.g., NACA mortgage)
- save a certain amount of money each month
You can learn about programs local to you by asking your bank/credit union, real estate agent, mortgage broker, lender, etc.
8. Get a co-borrower
A co-borrower applies for the mortgage loan together with you. Usually, your co-borrower is going to be your spouse or a life partner. But it could also be a friend or family member.
The advantage of adding a co-borrower to the loan is that both of your incomes and credit profiles are factored into the application.
Depending on their income and credit history, you may be able to qualify for a higher loan amount, lower interest rate, and lower required down payment. Also, the overall loan approval process may be easier.
Keep in mind if your co-borrower also has significant student loan debt and other monthly obligations, adding them to your application may hurt your application.
Need help lowering your student loan payment to buy a home?
When you're trying to become a homeowner and have a lot of student loan debt, it helps to have someone in your corner who understands the guidelines for each mortgage program and understands the options available to modify your payment terms.
I can help you take the steps necessary to help squeeze your student loans into your DTI ratio. Schedule a free 10-minute call with me today. We'll go over possible options and alternatives available to you.