By: Preston Mangus
In my previous blog posts, we’ve discussed student loan basics and tips for paying off student loans. This week, I’d like to delve deeper into a question that many student loan borrowers face: Will I be able to take on a mortgage if I am still paying off my student debt? Graduating from a reputable college or university, landing a steady well-paying job after graduation and eventually buying a home have long been the American dream. However, according to Make Lemonade, 44 million student loan borrowers today owe around $1.4 trillion, roughly averaging $37,000 per student. This debt burden has made it increasingly difficult for these individuals to qualify for large loans—especially mortgages.
Why? According to studies at the Cleveland Federal Reserve, over 40% of borrowers with student debt commit around 20% of their income to loan repayment. This can cause potential borrowers to be above established debt-to-income (DTI) ratios necessary for mortgage lending.
How do you calculate your DTI, you ask? Here’s an example. Suppose your gross income is $4,000 per month. For the purpose of a hypothetical calculation, let’s say your credit card and other forms of debt run about $300 per month and your student loan debt adds another $600 monthly. To calculate your DTI ratio, divide your monthly debt by your monthly income—or, say, $900 divided by $4,000 for this example. This yields a DTI ratio of 22.5%. The Federal Housing Administration (FHA) standards for mortgage qualification require a maximum DTI of 43%.
In the example above, you are already over halfway there without a mortgage payment, which would include principal, interest, taxes, insurance, mortgage insurance and other costs. That would limit your potential home buying market to dwellings for which the total monthly payment would be $820 or less. These conditions would likely make it quite difficult to complete a home purchase that could work for your needs. In fact, statistics from the Cleveland Fed indicate a significant reduction in mortgages from the pool of people 18 to 30 years of age, presumably due to the additional financial burden of student loans.
In light of these challenges, government-backed mortgage lender Fannie Mae has introduced some new policies and innovative solutions that could potentially help borrowers who are burdened by student debt. Basically, three changes were recently enacted:
- Cash-Out Refinance: The costs of cash-out refinancing have been lowered or eliminated, as long as cash from equity is used to retire student loan debt. According to Fannie Mae, there are an estimated 8.5 million borrowers who may benefit from this measure, especially parents with Parent Loans for Undergraduate Students (PLUS) loans.
- Debt Paid by Others: If you can demonstrate that specific debts—such as car loans, credit cards and student loans—have been paid by others for at least 12 months, this debt can be excluded from calculation. This could make a dramatic difference in DTI ratios.
- Student Debt Payment Calculations: Previously, lenders were instructed to use a minimum of 1% of student loan balance outstanding, as opposed to the actual payment amount, for DTI calculation. Using the actual payment, which may be significantly lower, will also improve the DTI percentage for lenders. Again, evidence of these consistent payments will be necessary for implementation.
These new provisions could make the difference between buying and renting! To find out if these changes could benefit your financial situation, call us at (904) 777-6000 or 1 (800) 445-6289 or visit your nearest VyStar branch location. One of our Home Loan Advisors will be happy to help you plan ahead and help ensure the highest potential for your home-buying success.
Here are also a few old-fashioned ideas that are always beneficial for mortgage negotiations:
Protect your credit score: An excellent credit report will be a positive in pursuit of borrowed dollars. Pay on time, and check your credit bureau report for free at least once a year at AnnualCreditReport.com.- Start saving: Once you have your emergency fund in place—at least three months’ worth of expenses—start saving for the down payment. Typical down payments for homes range from 5% to 25%. Federal programs—such as those offered by the U.S. Department of Veteran Affairs (VA), the Federal Housing Administration (FHA), and the United States Department of Agriculture (USDA)—assist many buyers at lower down payment levels. You must meet certain requirements to qualify for federal loans, and your Federal Student loans must be current. Remember: Your down payment will reduce the amount financed and the need for private mortgage insurance, plus it can be a source of immediate equity.
- Pay down other debts to reduce your DTI. Plan ahead for a mortgage—you could accelerate your fixed payment debts to close a loan, or make a concerted effort to reduce revolving accounts to lower your open balance. The key is to reduce the amount of debt going into the DTI calculation. And don’t take on any new debt!
- Aggressively pay down student loan debt. The one sure way to reduce your student loan portion of DTI is to pay down the balance. Some employers are using student debt relief as an incentive for hiring. Look for these opportunities when job searching. Finally, ensure that you are taking full advantage of programs designed to lower your monthly payments as previously discussed. The new rule changes will apply the lower payment number to the DTI computation.
Unfortunately, there’s no “magic bullet” solution to a mortgage. It takes planning and effort; however, hopefully these new rule changes will provide needed relief to the many people who are working hard to achieve the American dream.
Finally, there is talk of the possibility that Fannie Mae may increase the DTI threshold to a higher percentage—maybe 45 to 50%—effective later this year. Stay tuned!
P.S. The changes mentioned above have in fact been implemented as of September 26, 2017. The absolute highest Debt to Income ratio for approval is now 50% DTI. There will be acceptance of DTI exceeding 45% DTI if Credit Score criteria are met. The best option would be to discuss your particulars with one of our Home Loan Advisors to ensure underwriting eligibility. As you might expect, there are some very specific requirements to qualify; but another opportunity to perhaps obtain that mortgage!
The content provided in this blog consists of the opinions and ideas of the author alone and should be used for informational purposes only. VyStar Credit Union disclaims any liability for decisions you make based on the information provided.