Student-loan debt? You can still qualify for a mortgage
Worried that your student-loan debt will hurt your chances of qualifying for a mortgage? You’re not alone. The average graduate in the class of 2016 is leaving college with $37,122 in student-loan debt, according to Student Loan Hero. That’s up 6 percent from the previous year.
"Unfortunately, student-loan debt negatively impacts one's ability of getting a home mortgage," said Diana Ospina, a loan officer with New York City-based Quontic Bank. "The number-one question I ask prospective borrowers is, 'Do you have student-loan debt?'"
But here’s some good news: New lending rules are making it easier for such borrowers earn a “yes” from a mortgage lender. The key is to understand what these rule changes mean, maintain a stellar credit history and come up with as large a down payment as possible.
Do all three and that student-loan debt might not keep you from financing a home.
The student-loan challenge
Student loans can make it more difficult to qualify for a mortgage because lenders look carefully at your monthly debt obligations when deciding if you can afford home-loan payments. Lenders typically want your total monthly debts, including your new mortgage payment, to equal no more than 43 percent of your gross monthly income.
If your student-loan payments push you past this 43 percent mark, you might struggle to qualify for a home loan.
There is good news, though, for borrowers burdened with student-loan debt. Earlier this year, Fannie Mae, which guarantees a large percentage of mortgage loans, unveiled new rules designed to make it easier for borrowers with student-loan debt to qualify for home loans.
Easing the burden
In one of the more important of these rules, lenders originating mortgages guaranteed by Fannie Mae no longer must count the non-mortgage debt that other people are paying on behalf of borrowers. If your parents, then, have agreed to pay your student-loan debt, credit-card debt or auto loan, mortgage lenders will no longer count this debt as part of your debt-to-income ratio.
Fannie Mae has also launched its HomeReady mortgage designed to help borrowers who, in addition to other financial hurdles, are paying off large amounts of student-loan debt.
Under the HomeReady program, both first-time and repeat homebuyers only need to come up with a down payment of 3 percent of their home's purchase price.
In a big change, lenders originating a HomeReady loan can also count income from household members who are not listed as borrowers on the mortgage. This means that borrowers can count income generated by their children, grandchildren and other extended family member if that family member is part of the household.
Lenders can use this income even if these family members' names are not listed on the mortgage. This could be a significant help to borrowers whose debt-to-income ratios would be high in part because of student-loan debt.
In a written statement, Jonathan Lawless, vice president of customer solutions for Fannie Mae, said that the new rules are needed as college graduates borrow ever more money to complete their studies.
"We understand the significant role that a monthly student-loan payment plays in a potential home buyer's consideration to take on a mortgage," Lawless said.
Changing the 1 percent rule
Steven Esses, senior loan officer with Brooklyn, New York-based FM Home Loans, said that another change from Fannie Mae is playing an even bigger role.
When determining the average monthly student-loan payments of their borrowers, lenders traditionally used a figure equal to 1 percent of borrowers' outstanding student loan debt. The problem with this method? That 1 percent figure could be more than the actual amount that borrowers were paying on their student loans each month.
"This resulted in borrowers not qualifying for a mortgage or qualifying for much less than anticipated," Esses said.
Fannie Mae's new guidelines, though, allow lenders to use the monthly student-loan payments that are actually reported to the three national credit bureaus of Experian, Equifax and TransUnion. If the actual payment is lower than the 1 percent figure, this could lower a borrower's debt-to-income ratio, making it easier for this borrower to qualify for a mortgage.
Kris Constantino, a residential mortgage lender with Old Second National Bank in Aurora, Illinois, said that borrowers will still face challenges when applying for a non-conventional mortgage, a loan guaranteed by the federal government. For most borrowers, this means FHA or VA loans, mortgages insured by the Federal Housing Administration or the U.S. Department of Veterans Affairs.
With FHA loans, lenders must use the 1 percent figure when calculating their borrowers’ monthly student-loan payment.
Constantino uses this example: Say borrowers have a student-loan balance of $50,000 but are on an income-based repayment plan that lowers their monthly payments to $250. With an FHA loan, lenders will still use 1 percent of the student loan balance as these borrowers’ monthly payment. That’s a challenge because the 1 percent figure in this example would come out to a higher $500 monthly payment.
That higher monthly payment could mean the difference between borrowers qualifying for a loan or receiving a rejection. It could also mean that borrowers can only qualify for a smaller loan amount, Constantino said.
To boost your odds
Even with the rules changes, student-loan debt can still lessen your chances to qualify for a mortgage. Fortunately, there are steps you can take to increase your odds.
First, make sure that your three-digit FICO credit score is strong. Lenders today consider FICO scores above 740 to be particularly strong. You can achieve such a score by paying your bills on time each month and paying off as much of your credit-card debt as possible. Lenders look at borrowers with high credit scores as less of a risk to default on their loans, even if they do have higher monthly debts than are ideal.
Paying off credit-card debt is important, too. It not only helps your credit score, but your debt-to-income ratio, too. As you reduce your credit-card debt, you’ll lower the amount you must pay to your credit-card providers each month, lowering your monthly debt obligations.
Increasing your income each month could also lower your debt-to-income ratio. This might mean applying for a higher-paying job or taking on a permanent side job.
Ospina says that borrowers can increase their chances of qualifying for a loan, even if they are paying off student loans, by coming up with a larger down payment.
"While student-loan debt does affect the mortgage-lending process, it boils down to three factors: income, savings and credit," Ospina said. "Your mortgage professional will look at those three variables to determine what loan you qualify for, if any."