For many people, high student loan balances are one of the main barriers to achieving homeownership. Student loan debt can cause many first time home buyers to not qualify for a home loan, or depending on the loan balance, they may decide to focus on paying off this debt first. If student loan debt has delayed your dreams of owning a home, a recent change in FHA guidelines could make it easier to qualify for an FHA home loan.
The Original Guideline
In the past, the old guideline stated that lenders were required to use 1% of your total loan balance when calculating your debt-to-income (DTI) ratio. In addition, income driven repayment plans could not be used to calculate DTI ratios. This was a huge problem for student loan borrowers, and here’s why:
The average student loan debt for those who pursued a bachelors degree is around $30,000, and the average student loan debt for those who pursued a masters degree is around $70,000. Neither of these averages are remotely close to student debt for those who attend medical or law school.
So let’s just say you have $50,000 worth of student loans, and you decide to submit an application to get pre-qualified for a mortgage. The lender will calculate your debt-to-income ratio to determine if you pre-qualify. When looking at your student loan balance, they will calculate 1% of $50,000 which is equals $500. $500 will be considered your monthly student loan payment, and they will factor this into your monthly DTI. But what if you’re on an income driven repayment plan that only requires you to pay $150 per month? This is where the problem is. In reality, most borrowers aren’t paying any where near 1% of the outstanding loan balance each month which is causing an inaccurate picture of their monthly DTI ratio.
The New Guideline
The Federal Housing Administration (FHA) announced, in June 2021, that they’ve updated their guidelines on how they require lenders to calculate student loan debt for FHA loans. The goal of this change is to help eliminate barriers to homeownership. These new guidelines will allow a lot of first time home buyers to have a better chance in pre-qualifying for a mortgage.
The new guideline states that no matter if the student loans are currently being paid, in deferment or in forbearance, mortgage lenders are required to use a borrower’s ACTUAL monthly student loan payment, even if it is below the traditional amount of 1% of the total balance.
If a student loan borrower’s calculated payment is $0 (which is possible under an income-driven repayment plan, or in forbearance), mortgage lenders will use 0.5% of the outstanding student loan balance as an assumed payment, rather than 1%.
So back to the example I used earlier, if you have $50,000 in outstanding student loan debt and your current monthly payment is $0, the lender would calculate 0.5% of the $50,000 towards your DTI ratio which is about $250.
As a result of this new magical change, many student loan borrowers will be able to qualify for a home that they would not have qualified for weeks ago. This is huge, so make sure everyone you know that has student loan debt is aware of these new guidelines. Many lenders are already using the new guidelines for underwriting/qualifying purposes.