The Student Loan Problem (And The Fix)

We all know that student loans are a big problem for many Americans.  You may not realize, though, that they became a big problem for many home buyers in 2016 as well.

Why is that, you ask?  I'm happy to explain!

In 2016, the rules for how student loan payments are counted when someone is buying a house got a whole lot tighter.  Previously a lender could work off of the payment showing on the credit report.  If the buyer was on an income based repayment (IBR) plan and the payment was lower because of that, great!  If the student loan was deferred and wasn't going to start repayment for 12 months or more, all the better.

In those cases, a lender was able to count that lower IBR payment or possibly even that zero deferred payment and, because of that, allow the buyer to qualify for a more expensive home than they would otherwise.

In 2016 though, that changed.  Both FHA and Fannie Mae changed their requirements to read that a lender now should count 1% of the student loan's balance in their payments when determining how much they qualify for.

OUCH!  Let me share some math on how much that can hurt a home buyer.  Let's say a buyer works full time making $12.50 an hour which is $2,166 per month pre-tax.  A lender will target them having monthly bills of no more than 45% of this pre-tax income and that number needs to include the new mortgage payment they are requesting.

So...$2,166 x 45% gives you $974 of monthly bills allowed.  Now, if this buyer has $40,000 in student loans that are deferred but the lender has to count 1% of the balance as a payment, that's a $400 payment that needs to come out of that $974, leaving just $574 for everything else.  Let's say they have a $250 car payment and $60 per month in minimum credit card bills, and suddenly you're down to $224 left for the new mortgage payment.

Even in a lower priced market like mine, $224 isn't going to be enough to get a house for most buyers.  So...what's the fix?

There are two possible ways to work around this. First, if there is a payment showing on the credit report and we can show that it is a fully amortizing payment, we can use it even if it's under 1%.  It's going to take some extra legwork to prove this though.  A lender would need to get a copy of the original note from the borrower containing the interest rate and loan term to confirm that the payment on the credit report will pay it off on time.

If the payment will not pay it off in the original term, there is one more option.  Instead of using Fannie Mae or FHA for the loan approval, the lender can run the loan through Freddie Mac.  Freddie and Fannie are the  two government sponsored enterprises that basically drive the mortgage industry and Freddie is currently offering a bit more flexibility on this issue.  Freddie alone will allow a lender to use the lower IBR payment showing on the credit report when approving a buyer.

So why doesn't everyone with student loans just use Freddie for their loan approval then? There are two main reasons.  One, they may not qualify.  Some people need to use FHA financing because of newer or bruised credit or tighter debt/income.  If that's the case, they will have to use that 1% or fully-amortizing rule which may rule them out for a home purchase.

Also, some lenders don't offer Freddie for their buyers.  They're strictly a Fannie lender, so their clients will have to abide by the 1% or fully amortizing rule as well.

So what does this mean for home buyers today?  It means that, while it is harder to get approved for a mortgage when they have student loan balances, there may be options. If you have been told you don't qualify because of your student loans, ask your lender if they looked into documenting that your loans were fully amortizing.  Ask them if they looked into running your approval through Freddie Mac. If they're unable or unwilling to take these extra steps, feel free to contact me for a second opinion (lori.hiscock@ruoff.com). Or, hey, just come to me first! Whether we can do it now or we need to create a plan to get you there in time, student loans don't have to stop you from owning a house of your own.

To learn more about the products covered here or any other aspects of home financing, contact Lori Hiscock at lori.hiscock@ruoff.com.  

Lori Hiscock is a Sr. Loan Officer at Ruoff Home Mortgage‘s South Bend office.  One of Michiana’s top mortgage loan officers, Lori started her lending career in 1995 after obtaining her bachelor’s degree in Finance from Western Michigan University.  You can connect with Lori Hiscock or apply online here. NMLS#404320.

Ruoff Mortgage Company, Inc. is an Indiana corporation licensed by the Indiana Department of Financial Institutions (DFI) and operates with the following licenses:

Indiana-DFI First Lien Mortgage Lending License #10994;
IL Residential Mortgage Licensee #MB.6760734;
Michigan 1st Mortgage Broker/Lender License #FL0017496.

Ohio Mortgage Broker Act License #MBMB.850220.000

The Florida Office of Financial Regulation License #MLD1182