For those with debt-deferred dreams of homeownership, the path just got a bit easier.
The Federal Housing Administration (FHA) recently made changes to student loan payment calculation requirements that have historically prevented individuals with student loan debt from qualifying for a mortgage.
FHA's new student loan calculation could make it easier for student loan borrowers with payments that are not fully amortizing or currently in repayment to be approved for a mortgage.
The debt-to-income ratio is a total of your monthly debt obligations divided by your gross monthly income, and that ratio is one way lenders measure a borrower's ability to repay their home loan.
FHA mortgage lenders previously used 1% of a student's outstanding loan balance to calculate the overall debt-to-income ratio, and for loans that were in deferment or forbearance or currently in an income-based repayment plan, that formula often overestimated the student loan payment. With higher debt-to-income ratios, many potential borrowers were denied loans or approved for lesser amounts.
The new guidelines cut the requirement to half of 1% because it is more reflective of the monthly student loan payment—not the lump sum owed.
"Going from 1% to half a percent doesn't sound like much—but it can make a big difference," said Julie Haddock, senior sales manager at BOK Financial MortgageSM.
She said it is easy to get lost in the weeds on a rule change like this, but how it plays out could look something like this: Jack, who has $50,000 in student loans that are currently in forbearance, is trying to get a $100,000 loan to buy his first home. He recently graduated college and is in an entry-level position in his new career field.
Student loan payment calculation changes
The Old Way
Because Jack's student loan was currently deferred, FHA required lenders to assume a payment of 1% of Jack's outstanding student loan debt, calculated at $500. That doesn't sound like much, but if Jack is earning $3,000 per month, for example, it can make or break his monthly budget. If Jack's mortgage loan required a 45% debt-to-income ratio; that would amount to $1,350 of his $3,000 salary. Deduct the assumed $500 student loan payment from that, and Jack would be left with only $850 for his monthly mortgage payment. Add in a car loan, credit cards, or other sources of debt, and Jack's available income to pay his mortgage would be even less.
The New Way
Half a percent would be only $250. In this scenario, with the same debt-to-income ratio conditions, Jack would have $1,100 to put toward a mortgage payment (and other outstanding monthly debts).
"When it comes to mortgage payments, that's a massive difference," said Haddock. "This also changes what amount he would qualify for on a home loan; it could be $110,000 versus $140,000."
A typical FHA borrower might be someone with credit issues in the past, or individuals who need a larger threshold of debt-to-income exposure. This is because FHA typically allows for a higher debt ratio than a conventional loan and can be more lenient when it comes to determining the rate for credit-challenged borrowers.
Reports from FHA show that more than 45% of first-time borrowers have student loan debt and the previous guidelines negatively impacted people of color, in particular.
"This change helps broaden the eligible buyers and opens up a lot of options for first-time homebuyers , new college graduates, or young professionals with student debt lingering over their heads," Haddock said.
She said it also creates the opportunity to purchase in more ideal areas—better suited to the buyer's needs, like proximity to work, childcare, public transportation or family.
“Cutting the requirement to half a percent to allow for new homeownership may be the catalyst for changing a person's financial trajectory. It can be the difference in renting versus gaining wealth and laying roots in your community.”- Julie Haddock, senior sales manager at BOK Financial Mortgage
Considerations
For those carrying student loan debt who may want to take advantage of the FHA rule change, Haddock offered these tips:
- Find a Realtor® and financial advisor you trust.
- Know what your credit score is and how to boost it.
- Make sure your bills are paid on time.
- Pay down revolving debt (like credit cards) as much as possible (at least) 45 days before applying for a home loan.
- Round up pay stubs covering 30 days and W-2s for the past two years, so you have the best information available to understand and report your income.
- Document your previous employment (and education) dates covering two years.
- Have a list of your addresses for the past two years and how much you were paying in rent.
- Make a budget and determine how much you're willing to pay for a mortgage (and associated costs).
- Know how much of a down payment, if any, you can bring to the table. And make sure your money is in a verifiable bank account.
"The change is a fraction of a percent, but it could change entire financial futures," Haddock said. "It could create generational wealth; it could change the face of a community. It opens the door to a lot of possibilities, especially for underserved communities that have found it difficult to get into homeownership."
. © 2024 BOKF, NA.