Getting a First Mortgage With Student Loans Just Got Easier

Getting a First Mortgage With Student Loans Just Got Easier
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If student loan debt is delaying your dreams of owning a home, the latest change may make it easier to qualify for an FHA home loan.

The Federal Housing Administration has updated how lenders are required to account for FHA student loan debt. The goal is to remove student debt as a barrier to entry for an FHA home loan — the FHA says more than 45% of first-time borrowers have student loan debt and previous guidelines have negatively affected people of color in particular.

The change has the potential to increase access to FHA-backed mortgages for disadvantaged communities and those with student debt — and some previously ineligible borrowers could now qualify under the change. The people who benefit the most are low-income debt-burdened borrowers, says Catalina Kaiuraungs, co-founder of student debt financial wellness platform LoanSense.

Here’s what this change means for you:

Getting an FHA loan just got easier

For loans that are not in active repayment (forbearance, deferment, and income-based repayment plan), the guidelines previously required FHA mortgage lenders to calculate the borrower’s monthly student loan payment using 1% of the total loan balance. This amount was then taken into account in the debt-to-income ratio (DTI), which negatively affected the possibility of borrowing.

For example, a borrower might have a total balance of $100,000 in student loans. But they may be on an Income-Based Payment Plan (IBR), where they contribute just $150 a month. Under the old guideline, the FHA lender must calculate $1,000 per month, based on the underwriting rule of 1% of the balance.

Now, anyone who takes advantage of an income-based payment plan can get the actual dollar amount they pay into their DTI account, as long as the payment is more than zero dollars per month. And if your student loans are active or deferred or your monthly IBR payment is zero, 0.5% of your student debt will be listed on your DTI.

Like most loan programs, FHA loans have a debt-to-income (DTI) limit. DTI is the main factor that lenders use to determine how much they are willing to allow you to borrow, and student loans form part of this assessment. This includes your current monthly debt payments and future mortgage payments.

These changes must be implemented by August 16, the FHA says, although lenders are also allowed to implement them immediately.

How it works

In most cases, the maximum DTI allowed on an FHA loan is 43% of your monthly income. To calculate your DTI, take your debt payments and divide this number by your gross monthly income (before taxes).

Here is an example of a scenario for how a potential FHA borrower would be affected in an income-based repayment plan under the old and new guidelines:

old way

Monthly debts (car and credit card payments) $450
Monthly repayment of IBR student loan $150
Monthly income 3500 dollars
Total Student Loan Balance $100,000
Used to calculate monthly student debt $1,000/month (1% of loan)
Total monthly debt used in DTI $1450 a month
DTI ($1450 / $3500) 41.42%

new way

Monthly debts (car and credit card payments) $450
Monthly repayment of IBR student loan $150
Monthly income 3500 dollars
Total Student Loan Balance $100,000
Used to calculate monthly student debt $150/month (actual payment)
Total monthly debt used in DTI 600$/month
DTI ($600 / $3,500) 17.14%

In the example above, the reduction in DTI is significant and can make a big difference in qualifying potential. The change can also affect the amount one can borrow as well. Lowering the DTI increases the purchasing power of homes.

Who Can Benefit from New Eligibility Rules for an FHA Loan?

Prospective home buyers

For buyers, this change can mean two things:

  1. You can qualify when you can’t before
  2. You may qualify for a larger mortgage

But for those who want to buy a home, it’s a tough market right now no matter what kind of loan you get. Falling home inventories and exceptionally low mortgage rates have led to bidding wars and caused home prices to soar. While the change may make it easier for first-time homebuyers to obtain an FHA loan, it is not likely to be a major game-changer.

“It will be interesting to see over the next three to six months how this change impacts the market,” says Matthew Garland, division director at Garland Mortgage Group and co-host of the real estate podcast Rants & Gems. “I think this will continue to drive the sellers market and continue to drive home prices nationwide.” In other words, the challenge of finding an affordable home and getting your offer accepted will likely continue.

This makes it especially important to have a home buying budget and stick to it. Banks are often willing to lend buyers far more than what makes sense for people’s monthly budgets. That’s why it’s important to focus on what you can afford and not just how much the lender is willing to give you. FHA loans have a maximum DTI of 43%, but if “compensating factors” are taken into account, such as a down payment or cash reserves, you may qualify for a higher DTI.

professional advice

The maximum DTI amount for an FHA loan is 43% or higher, but many experts suggest keeping your DTI at 36% or lower since 43% does not account for other daily expenses.

Another important note: Your DTI does not take into account all of your monthly expenses, such as taxes, groceries, gas, maintenance costs, and unexpected medical bills. This is why some experts recommend that you follow the 28/36 rule. This rule states that your mortgage amount must be no more than 28% of your monthly pre-tax income, and all of your debt payments (including the mortgage) must be no more than 36% of your total monthly income.

potential funders

If your student loan debt is the only thing stopping you from refinancing into a new FHA loan, it’s worth looking at how much you might be able to save now. “For people who want to refinance, it’s a housekeeping operation,” Garland says. “If they’re on an income-based payment plan, we can use that payment to help them qualify, and now they’re able to refinance and get a lower rate.”

Keep in mind that you will pay closing costs of 3% to 6% of the balance when you refinance. FHA loans have an additional upfront mortgage insurance premium of 1.75% of the mortgage balance in addition to the ongoing mortgage insurance payments.

Compare the refinancing options that you qualify for before you decide if FHA refinancing is the right option for you. You will also need to make sure you stay at home long enough for potential savings to outweigh the costs of refinancing.

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