The cost of college in America continues to rise. According to Student Loan Hero, Americans now owe more than $1.48 trillion in student loans, and the average graduate from the class of 2016 has $37,172 worth of college debt.
While this certainly isn’t ideal, your debt doesn’t have to get in the way of your other life goals. Major mortgage investors like Freddie Mac and FHA have put policies in place to allow people with college debt to responsibly obtain home financing while paying off their student loans. After all, you went through all that schooling to get a job that pays for the needs and wants in your life.
Understanding Debt-to-Income (DTI) Ratio
Before we get into what’s changing, let’s talk a little bit about why it’s important.
When any mortgage lender, including Quicken Loans, determines how much you can afford, they look at two things: your total qualifying income and your debt. Taken together, these two items make up a very important ratio known as debt-to-income, or DTI.
In its simplest form, DTI compares your minimum monthly debt payments to your total monthly income. The lower this number, the more money you qualify to borrow. Let’s do a quick example.
You earn $4,000 per month. You have a $300 car payment, a $600 student loan payment, $400 in minimum credit card payments and a $200 personal loan payment.
In the example above, your total DTI is 37.5% ($1,500/$4,000). It’s not a hard-and-fast rule because it depends on what kind of loan you’re trying to get, but a good guideline is to keep your DTI no higher than 43% for the best chance of approval.
With that in mind, how is your minimum student loan payment calculated? That depends on who your mortgage investor is. We’ll give more info on what you need to know about loans from other investors later on in this post, but for now, let’s touch on Freddie Mac and FHA because their guidelines have recently changed.
New Student Loan Guidelines for Freddie Mac and FHA
Freddie Mac and the FHA have recently changed how student loans are taken into account in your qualifying DTI. Let’s go over what these changes mean, starting with Freddie Mac.
If you’re getting a conventional loan from Freddie Mac and you have student loans, here’s how they’re accounted for in your DTI. If your loans are in deferment or forbearance, the qualifying payment is the greater of the following:
- the actual payment shown on the credit report
- 1% of the original or outstanding loan balance, per month, whichever is greater
If the loan is in repayment, the greater of the following are used to determine the qualifying payment amount.
- The payment as reported on credit
- 5% of the original or outstanding loan balance, per month, whichever is greater
If you had a $20,000 loan balance on your student loans, your assumed monthly payment would be $100 for the purpose of your DTI (.005×$20,000).
Now let’s take a quick look at FHA.
The changes to qualification for FHA loans apply when student loans are in deferment or forbearance. Clients with these loans have an assumed repayment that’s the greater of:
- 1% of the outstanding loan balance per month
- the actual payment as reported on credit
- $10 per month
If the loan is being repaid, the guidelines are the same except that the payment on the statement can be used if documentation can be obtained that says the monthly payment will increase and the loan will be paid off in full with the current payment.
How Do Other Mortgage Investors Handle Student Loans?
Now that we know how things are handled with Fannie Mae and the FHA, what happens if you have a different mortgage investor? That’s a great question. Let’s quickly run through these.
Fannie Mae offers lenders several alternatives for calculating student loan payments. I’ve listed them below in order of priority.
- The actual payment on the credit report.
- If the payment is zero or not shown, 1% of the existing loan balance, per month.
- In many cases if that doesn’t work for the client, we can use the payment listed on the statement. It just has to equate to pay off the student loan fully by the end of the student loan term.
Finally, if you’re on a repayment plan that’s income-based, you may be able to qualify with a $0 payment if you can show documentation of a payment plan. If this is the case, your student loan payments don’t have to be included in your DTI.
On USDA loans, student loans are handled as they would be on FHA loans with the exception of the following. If the loan is in deferment or forbearance, the number used to calculate DTI the greater of:
- 1% of the outstanding loan balance, per month
- $10 per month
If the student loan is in deferment and repayment is not scheduled to begin in the next 12 months, it doesn’t need to be included in DTI.
If payment begins in the next 12 months and the loan is deferred, your DTI calculation is 5% of the existing loan balance divided by 12. It can be tough to wrap your head around that, so let’s go through that with an example.
If you have $30,000 in student loan debt, your minimum monthly payment calculated into your DTI would be $125 (.05×$30,000/12).
If you’re already in a repayment period at the time of your application, your DTI is calculated with the greater of the following:
- 5% of the outstanding balance divided by 12
- the payment listed on your credit report
Do you think you’re ready to buy or refinance a home of your own? You can get a preapproval to purchase or a refinance approval online through Rocket Mortgage. If you’d rather get started over the phone, you can talk to one of our Home Loan Experts at (888) 980-6716. If you have any questions, you can leave them for us in the comments below.
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