Buyers Benefit from New Student Loan Regulations
Student Loan debt in the United States has reached $1.4 Trillion. It has become one of the primary roadblocks for buying a home for millions of Americans.
For those not familiar with how this debt affects your ability to obtain a mortgage, allow me to demystify it a bit. Lenders want to know your debt to income ratio. This is the amount of income vs. expenses you, as a borrower, are responsible for on a monthly basis.
First off, are your housing expenses (Front end Debt to income ratio) and overall obligations (Backend Debt to Income Ratio) within the limits of the loan you are attempting to obtain? To qualify for a conventional loan you must have less than 28% DTI on the front end and 36% on the backend. The FHA loan requirements state that you need less than 31% front end DTI or 43% total DTI.
If you are already paying a regular monthly payment on your student loans you would include this monthly total in the back end debt to income ratio. If you are on a reduced payment plan lenders were previously required to calculate your monthly student loan debt at 1% of the total loan amount. That meant even if your repayment plan payment was just $80, but your loan amount was $40,000, the lender would factor in $400 a month in student loan obligations. I know, it’s enough to make you want to throw up in your mouth a little bit.
The good news is recently Fannie Mae and Freddie Mac (the ones who set loan qualification standards) changed this. Now, if you have a repayment plan, and it shows up documented in your credit report, they will use the reduced payment instead. Meaning using the $80 a month instead of the $400 a month as your student loan debt obligation factored into your back end debt to income ratio. Buyers benefit greatly from having this monthly obligation reduced.
This affects not only the ability to receive a mortgage but the amount of the loan. The lower your debt the more income available to pay housing expenses. It is important to note that this has not fully rolled out yet. While some lenders may be willing to work with these changes it has yet to hit Desktop Underwriter or Loan Prospector, which many lenders use to underwrite loans.
Cash Out Refinance
In addition to this change, Fannie Mae and Freddie Mac also introduced a new program that allows borrowers to turn their student loan debt into mortgage debt. I know, sounds real appealing right away doesn’t it? Ok, maybe not. It’s called the Cash Out Refinance Program. Now to be fair, a lot of the student loan debt out there is at a much higher interest rate than current mortgage rates so it may be a good plan for some. I could see the benefit for someone who has more than enough equity than the total balance of the student loans. However, let’s say you are five years into your mortgage. Adding $30-$100,000 to your loan balance traps you in that home until your home value exceeds the new mortgage+student loan balance. More concerning is the fact that the protections put in place for student loan borrowers who lose their jobs or become suddenly unable to pay go away when your loan is rolled into a mortgage.
In conclusion, Fannie and Freddie recognize that student loans are hurting potential home buyers. They are attempting to put measures in place to relieve the burden. However, as a consumer you still must take the time to do your due diligence to find out if the programs they are offering are the right fit for you.