How to Qualify for a Mortgage with Student Loan Debt
You might think it’s impossible to qualify for a mortgage while repaying student loans, but it’s not. Lenders treat them the same as your other installment debt when going through the qualification process – most of the time.
Historically, student loans came with regular monthly installment payments, over a certain number of months until the balance was paid in full. Now, however, they can have a variety of repayment terms, and some are pretty exotic. You can get a mortgage while paying your student loan if you qualify – and that’s the tricky part.
How to Qualify
The process starts with lenders calculating how much of your monthly income, before taxes, you would be obligated to pay towards debt if they loaned you the money to purchase the home you want to buy. On top of the monthly mortgage payment, they add the monthly payments for the debts on your credit report. The total can’t be more than 43-45% of your monthly income (the debt-to-income ratio) to qualify.
The wildcard is your student loan debt. If your payment is deferred, in forbearance, or you have an “Income Based Repayment (IBR)” plan, lenders must come up with a monthly payment amount to calculate your qualifying debt-to-income ratio. An IBR plan gives you a payment that’s a percentage of your discretionary income which, in some cases, might be a monthly payment of $0.
These repayment options create an issue for lenders because borrowers have an outstanding debt that must be paid back at some point. Lenders have to assess your ability to pay that monthly debt based on your current income and without a fixed payment that’s difficult. Currently, there are three different underwriting guidelines for calculating the payments in these situations.
Fannie Mae, Freddie Mac, and Federal Housing Administration (FHA) have all revised their guidelines addressing the repayment variations over the last two years. FHA’s revision occurred in the spring of 2016 and Fannie and Freddie updated their policies in 2018. Your mortgage lender will recommend a mortgage based on your ability to qualify under one of these different sets of guidelines.
Fannie updated their guidelines for student loans with an IBR plan that sets the payment at $0. Per their guidelines, “If the borrower is on an income-driven payment plan, the lender may obtain student loan documentation to verify the actual monthly payment is $0. The lender may then qualify the borrower with a $0 payment.” For all other student loans, the payment stated on the credit report or original documentation is used to qualify.
Also, the guidelines state “For deferred loans or loans in forbearance, the lender may calculate – a payment equal to 1% of the outstanding student loan balance (even if this amount is lower than the actual fully amortizing payment), or a fully amortizing payment using the documented loan repayment terms.” For example, if your student loan balance is $50,000 and deferred or in forbearance, the payment used for qualifying would be $500/month, or 1% of the outstanding balance.
If the underwriting guidelines for Freddie Mac are used to qualify you for the mortgage, the payment calculation is a little different than for Fannie Mae. The most current guideline changes as of January 2018 state “For calculating the monthly DTI ratio, use the greater of: The monthly payment amount reported on the credit report, or 0.5% of the original loan balance or outstanding balance as reported on the credit report, whichever is greater.”
While Freddie’s guidelines don’t allow for the use of a $0 monthly payment under an IBR plan, it does reduce the estimated payment by 50% compared to Fannie’s guidelines. That means for the same $50,000 loan balance example, the qualifying payment under Freddie is $250/month and with no requirement for documentation. But pay attention to the fact that they stress the greater of the outstanding or original balance must be used.
Freddie makes this distinction to take into consideration that IBR plans have the monthly payment amount recertified every 12 months based on your tax returns. There’s a chance that the payment may increase significantly, based on your income. Freddie’s guidelines explain “by requiring the use of a minimum payment of 0.5% of the original loan balance or outstanding balance, whichever is greater, the risk of the potential payment shock from the monthly payment increasing after the annual recertification is reduced.”
When the student loan is in forbearance or deferred, Freddie requires the estimated payment to be at 1% of the outstanding or original loan balance, whichever is greater. Using a higher qualifying payment in these circumstances allows for interest added to the loan balance during the deferral or forbearance period.
Freddie also makes provisions for loans that will be paid off within ten months or paid through an employer program, allowing for a $0 payment calculation with the proper documentation showing the circumstances. Besides, if another party, like your parents, has been making the student loan payments for at least the preceding twelve months, a payment is not included in the debt-to-income calculation.
The final version of student loan underwriting guidelines comes from FHA, and require you to document the actual payment due. “If the payment used for the monthly obligation is: less than 1 percent of the outstanding balance reported on the Borrower’s credit report, and less than the monthly payment reported on the Borrower’s credit report; the Mortgagee must obtain written documentation of the actual monthly payment, the payment status, and evidence of the outstanding balance and terms from the creditor.”
The only option for calculating a monthly payment regardless of the student loans repayment plan is the greater of:
- 1% of the outstanding balance on the loan;
- Or the monthly payment reported on the Borrower’s credit report;
- Or the actual documented payment provided the payment will fully amortize the loan over its term.
If you have a student loan, start the pre-approval process as early as possible. Your ability to qualify may require documentation that will take some effort to gather. Or you may learn that the monthly payment calculated for your student loan means repaying your other monthly debt before you can purchase a property. Ultimately, you won’t know what your possibilities are for owning a home without a thorough analysis.