The costs for higher education are among the fastest-rising costs in America today. In fact, since 1980, tuition costs at U.S. colleges and universities have risen a staggering 757 percent.
Unless you have the financial means to cover the costs associated with college upfront, you’ll need to apply for student loans.
The thought of repaying thousands of dollars in student loan debt can be scary. Add to that the concept of buying a home, it can be downright overwhelming.
However, it isn’t impossible to get a mortgage for a home if you have student loans, and it might even be easier than you think.
How student loans affect getting a mortgage
One of the primary indicators that impact your ability to obtain mortgage financing is your debt-to-income ratio.
Your debt ratios are determined by factoring how much debt you have divided by how much income you earn.
Your student loans can have a significant impact on your debt ratios.
This will vary according to the payment required on your student loans. It will also vary based on the type of mortgage for which you’re applying.
Generally, a good rule of thumb for how high your debt ratio can be, including your student loan payments, is 43%.
This means that when you calculate your student loan payments, your other payments (i.e. credit cards, auto, etc.) and then your new housing payment, ideally these numbers would fall at below 43 percent of your income.
Here’s an example of how your debt ratio could be calculated:
Student loans ($250) + credit card ($100) + car ($300) + mortgage ($1000) = $1,650 per month.
Let’s then say your income is $47,000 per year, or $3,917 per month.
Your total monthly debt of $1,650 would then be divided by $3,917. Using these numbers, your debt-to-income ratio would be 42%, and in what is traditionally considered to be good for lenders.
How student loan payments are calculated
There are a number of ways that student loans are repaid. Among them are:
- Standard repayment
- Extended repayment
- Graduated repayment
- Income-based repayment
- Income-contingent repayment
- Pay As You Earn repayment
Regardless of the way your student loan repayment plan is set up, the way your payment is calculated may or may not be in line with the way your mortgage lender does it.
Mortgage guidelines regarding how student loan payments are calculated by lenders have changed a lot in recent months. Until recently, if a student loan was deferred for at least 12 months, that amount was not required to be part of your debt ratio calculations.
Unfortunately, this has now changed for most mortgage programs.
The only mortgage loans that are still similar with regard to being able to use the deferred payment calculation are VA loans.
Per the VA, “if the Veteran or other borrower provides written evidence that the student loan debt will be deferred at least 12 months beyond the date of closing, a monthly payment does not need to be considered.”
If a student loan is in repayment or scheduled to begin within 12 months from the date of closing, the lender must consider the anticipated monthly obligation and utilize the payment in one of two ways:
- The lender must use the payment(s) reported on the credit report for each student loan if the reported payment is greater than the threshold for payment calculation above.
- If the payment reported on the credit report is less than the threshold payment calculation above, the loan file must contain a statement from the student loan servicer that reflects the actual loan terms and payment information for each student loan.
Additionally, the lender will need to calculate each loan rate at 5% of the outstanding balance divided by 12 months (example: $25,000 student loan balance x 5% = $1,250 divided by 12 months = $104.17 per month).
There are different guidelines followed for conventional loans depending on whether the loan is backed by Freddie Mac or Fannie Mae.
For Freddie Mac, if there is a payment amount reporting on the credit report, lenders are permitted to use the amount shown for debt ratio calculations.
This applies to income-based repayment plans as long as they are reporting on the credit report or if they have documentation showing the homeowner is in an established repayment plan is allowed.
For student loans whose repayment period has not yet started due to the homeowner still being in school, or if the payment has been suspended for a period of time, documentation needs to be obtained to verify the monthly payment amount included in the monthly debt ratio.
If no payment is being reported on the credit report on a student loan that is deferred or is in forbearance, one percent of the outstanding balance is used for calculating debt ratios.
For Fannie Mae, income-based repayment plans are not acceptable.
For all student loans, which are deferred or in forbearance, or in repayment (not deferred), lenders must include a monthly payment as structured below:
- One percent of the outstanding balance
- The actual payment that will fully amortize the loan(s) as documented in the credit report
- A calculated payment that will fully amortize based on the documented loan repayment terms, or
- If the repayment terms are unknown, a calculated payment will fully amortize the loan(s) based on the current prevailing student loan interest rate, and meet certain criteria imposed by Fannie Mae’s guidelines.
Regardless of the payment status, the lender must calculate both one percent of the outstanding loan balance and the monthly payment reported on the credit report. They then use whichever is larger.
Like with FHA loans, the lender must calculate both one percent of the outstanding loan balance and the monthly payment reported on the credit report. They then use whichever is larger.
Student loans & mortgage approvals
41 percent of college-educated Americans with student loan debt have actually postponed buying a home due to student loan debt.
It’s true that student loans affect your monthly budget and, in turn, affect your debt ratio, which impacts your ability to get approved for a mortgage.
However, student loans do not need to be considered barriers to entry when it comes to getting a mortgage.
Now that most mortgage programs are allowing the “one percent” rule with regard to repayment, it’s getting easier and easier to get approved for a mortgage, even with your student loans.