Student loans are a major issue in this country.  According to a report by the New York Fed, the average college student in 2018, graduates with nearly $40,000 in student loan debt.

Student loans have overtaken credit cards as the top type of unsecured debt. There are currently $1.48 trillion in student loans outstanding.

This is affecting mortgage qualification, since the debt from the student loan needs to be counted towards your debt ratio.

There are a lot of gloom and doom articles out there on this topic, but luckily, it’s not a total deal killer.

It takes a loan officer who understands the process of restructuring the debt the lower the payments and then matching that with a loan type that will accept Income Based Repayment (IBR) for qualification purposes.

If you aren’t familiar with income based repayment plans, be sure to visit my other post, The Complete Guide To Lowering Your Student Loan Payments.

Amazingly, because the level of debt doesn’t matter with Income Based Repayment, if you have decent credit and can qualify for Conventional financing, it’s actually possible to get approved for a mortgage with 6 figures of student loan debt!

How Mortgage Lending Works

Before I get into how student loans affect your qualification, you will need to understand a little bit about the process of mortgage lending.

In the United States, the vast majority of mortgages are funded through one of the following agencies: Fannie Mae, Freddie Mac, FHA, USDA, VA.

These agencies provide the funding for the loans to the mortgage company and in turn raise funds from Wall Street for mortgage funding through a process called securitization.

Each of the agencies listed above creates guidelines as to whether or not they are going to fund a particular borrower.

Additionally, some lenders will add their own rules on top of the guidelines. These rules are called overlays. As a side note, at PRMG we do not have overlays. We do everything at the minimum guidelines as required by law.

For student loans in particular, each agency has a different interpretation of how they view student loan debt. Having a loan officer that can match you correctly to the right program makes a huge difference in the approved loan amount and sometimes can make the difference between an approval and a decline.

Debt To Income Ratio

Your debt to income ratio, also abbreviated as DTI, is a measurement of how much debt you have relative to how much money you make. This is a major part of the mortgage qualification process.

The three pieces we look at are your credit score, your DTI and your level of savings (called reserves in the mortgage business). The combination of the  3 determines if you get approved or denied. Most of this approval process is determined by a computer algorithm and then verified later by an underwriter.

The debt ratio piece is determined by adding up your current debts, the proposed mortgage payment, including taxes and insurance, and then dividing that figure by your monthly income before taxes.

For example, someone with $5000 a month in pretax income and $2500 in debt payments has a DTI of 50%.

For most debts, this calculation is easy. For example, car loans have a level amount billed every month that we can use. For credit cards, we use the minimum balance that’s listed on the credit report.

Special Rules For Student Loans

With student loans, the calculation gets tricky and many loan officers totally screw it up.

This is because the agencies that I listed above have different rules as to how they count student loans. Even worse, these rules are constantly changing and many loan officers have not kept up with all of the changes.

For someone with a standard repayment plan of 10 years, or an extended plan of 25 years, it’s pretty simple. We just use the payment that’s on the credit report.

For people using forbearance, deferment or an income driven plan, things get murky quickly.

For example, when you are in a deferment or income driven repayment plan, VA says that we can use $0 as the debt payment as long as it will continue for 12 months after the loan closes. If it won’t continue for 12 months, the debt ratio formula for VA mortgages is the loan balance x 5% /12.

With most other mortgage types, we count 1% of the loan balance even though no payment is due. This can get problematic if you have a high balance relative to your income.

If you are on a deferment or forbearance and you need to change plans in order to get qualified, I can help you make those changes with your student loan servicer.

On An Income Driven Plan? Now It Gets Tricky

Income driven repayment plans are a great way to reduce your student loan debt payment. In many cases, using IBR is the only way you can pay the bill.

Most mortgage programs will ignore the income driven plan and instead make you use 1% of the balance for qualification purposes. If you owe a lot of money, this calculation could easily take you out of qualification.

Many loan officers mistakenly believe that the 1% rule applies to all borrowers on all mortgage types and this is not the case!

I’ve seen many applications get denied due to the loan officer using this erroneous information to qualify their borrower.

According to the Fannie Mae update published in mid 2017, Fannie Mae will count the payment listed on the credit report or the most recent statement as the payment for debt ratio calculation, even if it is $0. This applies to income driven plans only.

For deferment or forbearance, then the 1% rule still applies. However, it’s not that hard to change plans and I can help you do so.

This will be a huge help for many borrowers!

Home Ready vs FHA: Which Program You Use Makes A Difference

For many years, FHA was the best choice for homebuyers that want flexible qualifications for credit, use of gift funds from relatives, and higher debt ratio limits on its programs.

A couple of years ago, Fannie Mae came up with a product called Home Ready aimed at low and middle income borrowers that has a lot of the same flexibility that FHA has.

When it comes to student loans in particular, which product you use makes a huge difference, especially if you are getting a large payment discount from your use of an income driven repayment plan.

Consider this example…

Recently, a potential borrower applied with us who earned $52,000 a year and had $114,000 in student loan debt. However, due to  her use of income driven repayment, her payment was only $9 a month.

She is a social worker and plans on using the Public Service Loan Forgiveness (PSLF) program after 10 years of repayment.

According to FHA guidelines, we have to count that payment as $1140 (1% of the balance of $114,000). This put the debt ratio way over the qualification limit!

Under Home Ready guidelines, we can count it as $9, which easily keeps the debt ratio in line.

Certainly this is an extreme example, but this sort of thing happens all the time.

Sadly, many loan officers have bad or outdated information and are denying applications that should be approved!

Here is some more information about how Home Ready works and what you need to do to qualify for it.

Home Ready Product Profile