The Home Buyer's Korner

Information presented should be used for educational purposes only.

August 8th, 2014

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Student Loan Debt

Student Loan DebtStudent Loan Debt has become the single largest debt for Americans and overtaken first place for consumer debt. Not only has it become a serious problem for the nation, as a whole it affects your ability to qualify for a home loan. When you apply for a mortgage, it’s important to know just how student loan debt will affect you, even if it’s deferred or in forbearance.

Student loan debt is considered by your mortgage lender the way any other liability is and normally it will be considered in your debt-to-income ratio, which reduces how much home you qualify for. Home buyers with student loan debt who are planning to purchase a home may qualify for even less with a conventional mortgage loan versus FHA or VA financing. Simply because of strict Qualified Mortgage guidelines and less flexibility, underwriters have with an FHA home loan.

Fortunately, home buyers with student loans can use FHA financing when having higher DTI ratios, if the plan ahead.  It’s a tricky issue and your experience may vary depending on the circumstances of your loan application; the lender you choose and other factors, but in general it’s good to remember any debt listed in your name can and probably will be included in your debt-to-income ratio calculations.

Often times first time home buyers are fortune enough to have great parents who have been paying their student loan debt every month.  If that’s the case you’ll want to show the lender at least 24 consecutive months of your parents canceled checks and ask you loan officer if they’ll show the payment as cash “income” or a debt offset measure to compensate for the student loan payment.  The key here is, you’ll have to show the payments were never late and never missed by your PARENTS.  Missing just one payment or someone other than your parents making a payment over the 24 month period discounts any hopes of your mortgage lender compensating your income to offset the debt.  If you can reach this threshold you’ll also need to have a letter signed by your parents stating they have always planned on paying your student loan without your assistance.

Home buyers with deferred student loan have a host of issue to consider. Although many first time home buyer have set up a deferment, the debt can have several negative effects.  Deferred (or in forbearance) student loan debt grows in size, so the amount owed becomes more than the amount originally borrowed.

Unfortunately the FICO scoring formula will penalize your credit score because you owe more than you borrowed. Even though it’s a common practice, FICO considers it the same as if you exceeded your credit limit on a revolving credit card and lowers your credit score.

If you have a deferred student loan I’d highly recommend pulling your credit report several months before apply for a loan and see where the numbers are. You may want to consider paying down the student loan balance with a principal reduction, so that it doesn’t exceed the original loan limit.  But don’t do this without consulting your loan officer.

A simple rule to remember when considering a mortgage loan is conventional financing (Fannie Mae/Freddie Mac) does not acknowledge deferred student loans.  The future repayment amount must be calculated into your DTI ratio, even if mom and dad have been and plan to continue paying it.

If no monthly payment is reporting on the credit report, and you cannot document what the repayment amount is expected to be. Lenders must use a minimum 2%  and some use as much as 5% of the outstanding balance, as your monthly repayment amount. 

FHA and VA mortgages can omit student loan repayment amounts from your DTI ratio if you can document the student loan debt is or will be deferred for a minimum of 12 months from the date your mortgage loan funds, otherwise known as your closing date. Keep in mind if you close one day less that 365 day of deferment, NO compensation!

Be careful! All too often home buyers defer their student loan too early, which causes it to be deferred for less than 12 months, i.e. NO compensation.  Got It?

USDA requires deferred student loan repayments be included in the DTI ratio regardless of the terms, but does allow for 1% of the student loan balance to be used for repayment, if it’s not stated on your credit report and it seldom if ever is.

If your student loan is not in deferment and a payment is not shown, payments must be determined by other documentation, such as a letter from the student loan servicer or from your payment coupon.  USDA also has specific requirements when a student loan repayment is based on Graduated or Income Based Repayment (IBR) schedule.  Ask your loan officer for detail.

If you need assistance about how to get a student loan deferred or placed in forbearance and what is the difference, check out StudentAid, but again don’t act until you’ve spoken with your mortgage lender.

You would be amazed to know that many people get their mortgage loan denied at closing, because the loan officer was not aware that in community property states (Louisiana, California and several others), the non-borrowing spouse’s student loan debt  and any other federally back loan or tax liens are factored into the home buyer’s liabilities and DTI ratio.  If you live in a community property state and married review your spouse credit report, even if they aren’t going to be on the loan, so you don’t get caught up on this common mistake. 

Lastly, consolidation of a student loan might be your best option and I can’t say it enough, speak with your loan officer before taking any action.

Happy House Hunting!

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