New Mortgage Rules Make Borrowing with Student Loans Easier

A couple of years ago we published a piece about how to get a mortgage even if you have student loans. Back then the mortgage industry was different and eventually the information aged on us. It happens, we can’t possibly predict how things will change, all we can do is try to stay on top of those changes and do our best. This is the long-delayed replacement for that piece, outlining what it means to get a mortgage loan in 2017 with student loans.

It all started back in 2014, when I read this article in the LA Times. Basically, the piece is talking about the future impact of student loans on the housing market — which is still a very valid thing to fear, since Student Loan Hero reports that 2016 college grads have an average of $37,172 in student debt, a six percent increase from the class before them. I don’t think anyone is in denial that student loans are an increasing drag on our economy, but what to do about it in the face of rising college tuition is another question that we’re really not the right people to answer.

We’re the people to talk to about when you have burning questions about homeownership.

However, the long-term implications of fresh grads with almost $40k in debt right out of the gate could be massive. If they assume they can’t buy a home until that debt’s managed, well, that’s going to be a big issue for a market that’s continuing to try to recover without very consistent success. But all that aside, today, right now, we’re going to lay out what it’ll take for you to get a mortgage, even with a massive student loan, so pay attention!

What’s Up With that Student Loan Calculation Everyone’s Talking About?

So, in the news and all over social media and any place that indebted college grads who are looking to buy homes happen to congregate, there’s a great deal of talk about the “new” way of figuring student loan debt that many mortgage lenders are using. The basic drift is that despite whatever your actual payment may be, that mortgage lender will use a calculation based on your total indebtedness. For example, if you have $56,000 in student loans, your mortgage lender will figure a percent of that as your payment, say one percent. So for that loan, your payment would be calculated at $560, even if you only made $300 payments every month.

This gets more frightening for grads who are working off their time for debt forgiveness, where there’s typically not a payment required. These people might be filling a need in an underserved area, like teachers working with underprivileged inner city youth, or filling up the ranks of a profession that is in desperate need of more people, like large animal veterinarians. They’re even more in trouble in the loan payment calculation world, since they may have terrifying amounts of debt, but no actual payment due because of their various debt forgiveness programs.

So, does that mean that inner city teachers and large animal vets are just never going to be able to buy a house? Absolutely not. While the percentage payment is terrifying for some student loan holders, it’s not actually that cut and dry — if your mortgage lender tries to tell you it is, get a different lender right now.

FHA and Conventional loans are certainly using payment calculations, that’s a fact, but if their payment calculation is inaccurate you don’t have to take it. Just because they say that your $56k loan should have a $560 payment doesn’t mean it will — or that it even has a payment. Your payment might be something else entirely and that’s a number you can both support and defend. However, there are a few nuances here that have to be mentioned before we continue:

1. Your student loan must be able to fully amortize with your current payment. That is, your current payment has to be able to pay the loan off in full at the end of the term. So, if you’re making a $100 payment and your term is 10 years, well, you’d better be out of loan at the end of that term and not have anything left hanging.

My loans, for example, which total a greatly huge number, have been at a very low payment for the last five years due to the income-based repayment program. At the end of my 25 year term, they will absolutely not be paid in full. In fact, I may have $10k or more left on the loan, it’s hard to say at this point. In my case, the payment would not meet the first condition because the loan won’t fully amortize. I hope that makes sense.

2. You’ve got to be able to prove this is the payment over the long haul. The wording for FHA, for example, is “Regardless of the payment status, the Mortgagee must use either: the greater of 1 percent 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.” (Emphasis mine)

This isn’t any harder than it sounds — you just need to bring in some bills. Show your payment, prove it’s always the payment, and so on. This condition might apply if your interest rate is really low, for example, or your term is very long, or both. When I was an undergrad, there were several years where my rate was between three and four percent, so when I went to consolidate, that rate blended in with whatever the others were and it really brought my interest way down. When that’s combined with my 25 year consolidation, the calculations don’t work quite right because the bulk of student loan borrowers don’t have enough debt to qualify for or aren’t interested in the longer terms — and, of course, it’s based off of what most students do.

I’m going to put it another way, in case you’re more chartly inclined. There are two things to watch here, one is the actual payment, the other is the payment that your lender assumes you’re making based on the calculation. That calculation has made the industry go nuts, but stick to your guns. This is what I mean:

Actual DebtInterest RateTermActual PaymentEstimated 1% PaymentEstimated 2% Payment
$40,0005.25%25 years$239.70$400.00$800
$60,0008.00%30 years $440.26$600.00$1,200

So, for argument’s sake, let’s say you had a $40k student loan at 5.25 percent interest consolidated with a 25 year repayment — your actual payment is $239.70 and that will absolutely amortize. If your lender goes sideways on you and wants to figure your payment at one percent of the loan, well, they’re just wrong. There aren’t two ways about it — and that $160.30 can have a massive impact on your debt to income calculation.

What Can I Do If My Student Loan is Still Tripping Me Up?

If your student loans are still giving you fits, even with proof of your actual payment documented, the problem could be your term. This is one of those situations where you have to weigh the payment in the short term (while your earnings are still relatively low) against the interest you’ll pay in the long term. Sometimes it’s a really garbage choice, to be honest, but there are a lot of really garbage things about the student loan system — ours is to figure out how to get you into a mortgage. And if that’s your end game, the lower you can make that payment, the better off you’ll be.

So, if you have multiple loans or you have one giant loan that needs to be reconfigured, go back to your servicer and look into consolidation options. If you’re cruising on Stafford loans, go here and start the process. If you get a lower payment (with a longer term) so you can get a mortgage, and later start making more money, you can always prepay (there’s no prepayment penalty for student loans), make double payments or whatever you need to do to stay on track to pay them off sooner.

Please note that it can take months for a complicated consolidation to complete, so do this well ahead of time. Do it before you have your down payment saved up, do it now and be ready for a mortgage in a year or two. My student loan consolidation was a nightmare, several loans didn’t manage to get repaid with the first go but persistence eventually paid off. You’ll need to stay on top of this, but it will make it ok in the end.

Like we’ve discussed in other articles where debt to income is a big part of the problem, your other options are going to continue to be things like providing a bigger down payment, paying off other debts to free up some room and getting gift money from your parents or a favorite aunt. But because the student loans themselves seem to be so much the issue, that’s not really where I wanted to focus this piece — I want you to know that you have options and ways to make that student loan work with the rest of your debt.

The Bottom Line: Your Student Loan Isn’t a Guaranteed Mortgage Killer

No matter what type of loan you’re getting, be it a VA that uses an actual loan payment in the debt to income calculation or an FHA or Fannie Mae that wants to assume a one percent of debt payment (but will take an actual payment if you press it), you can get a mortgage. It might not be the amount you’d hoped for today and it might not be the program you’d hoped for, but there is potential here.

Today’s mortgages are still so cheap that it won’t make a huge difference if you’ve only secured an FHA because your debt to income was really high or if you were able to use a VA as part of your veterans benefits. The big thing is to get that mortgage, so make your student loan payment as low as you can in the months and even years leading up to your applying for your home loan. Freeing up more of that debt to income ratio will give you more room to move in the real estate market, no matter how hot your area gets.

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