Getting your first mortgage when you have a student loan just got easier

If student loan debt has delayed your dreams of owning a home, a recent change could make it easier to qualify for an FHA home loan.

The Federal Housing Administration has updated how it requires lenders to calculate student loan debt with FHA loans. The aim is to remove student debt as a barrier to entry to getting an FHA home loan – the FHA says more than 45% of first-time borrowers have student loan debt and the previous guidelines had a negative impact on people of color in particular.

The change has the potential to improve access to FHA-backed mortgages for underserved communities and those with student debt – and some previously ineligible borrowers may now be eligible under the change. The people who benefit the most are heavily indebted, lower-income borrowers, says Catalina Kaiyoorawongs, co-founder of LoanSense financial wellness platform for student debt.

What this change means for you:

Obtaining an FHA loan just got easier

For loans that are not actively being paid back (deferral, deferral, income-based repayment schedule), FHA mortgage lender guidelines previously required that the monthly payment of a borrower’s student loan be calculated at 1% of the total loan balance. That amount was then factored into their debt-to-income ratio (DTI), which negatively impacted their borrowing potential.

For example, a borrower may have a total of $ 100,000 in student loans. However, you can have an approved income-based repayment plan (IBR) and contribute as little as $ 150 per month. Under the old policy, the FHA lender would have to budget $ 1,000 per month based on the 1% balance underwriting rule.

Now anyone using an income-based repayment plan can include the actual dollar amount paid in their DTI as long as the payment is above zero dollars per month. And if your student loans are late, deferred, or your IBR monthly payment is zero, 0.5% of your student debt is counted towards your DTI.

Like most loan programs, FHA loans have a Debt and Income Line (DTI). DTI is the main factor lenders use to determine how much they want to loan you, and student loans are part of that assessment. This includes your current monthly debt payments and your 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 that number by your gross monthly income (before tax).

Here is a sample scenario of how a potential FHA borrower is affected in an earnings-based repayment plan under the old and new guidelines:

Old way

Monthly debt (car and credit card payments)$ 450
Monthly payment of the IBR student loan$ 150
Monthly income$ 3,500
Total student loan balance$ 100,000
Used to calculate monthly student debt$ 1,000 / month (1% of the loan)
In DTI. total monthly debt used$ 1,450 / month
DTI ($ 1,450 / $ 3,500)41.42%

New way

Monthly debt (car and credit card payments)$ 450
Monthly payment of the IBR student loan$ 150
Monthly income$ 3,500
Total student loan balance$ 100,000
Used to calculate monthly student debt$ 150 / month (actual payment)
In DTI. total monthly debt used$ 600 / month
DTI ($ 600 / $ 3,500)17.14%

In the example above, the decrease in the DTI ratio is significant and can make a huge difference in qualifying potential. The change can also affect how much you can borrow. Lowering the DTI also increases the purchasing power of home buying.

Who Can Benefit From The New FHA Loan Eligibility Rules?

Potential homebuyers

For buyers, this change can mean two things:

  1. You could qualify if you couldn’t before
  2. You could be eligible for a larger mortgage

But for those looking to buy a home, no matter what type of loan you get, it’s a tough market right now. Low housing stocks and exceptionally low mortgage rates have led to bidding wars and house prices soaring. While the change could make it easier for first-time home buyers to get an FHA loan, it’s unlikely to be a major game changer.

“It will be interesting to see how this change will affect the market in the next three to six months,” said Matthew Garland, division director of Garland Mortgage Group and co-host of the Rants & Gems real estate podcast. “I think this will continue to fuel the seller market and keep house prices higher across the country.” In other words, the challenge of finding an affordable home and getting your offer accepted will likely continue.

Therefore, it is especially important to have a home budget and stick to it. Banks are often willing to lend their buyers far more than people’s monthly budget allows. This is why it is important to focus on what you can afford, not how much a lender is willing to give you. FHA loans have a maximum DTI of 43%, but when certain “compensating factors” are taken into account, such as: B. Your down payment or cash reserves, you can qualify with an even higher DTI.

Pro tip

The maximum DTI for an FHA loan is 43% or more, but many experts suggest leaving your DTI at 36% or less since the 43% doesn’t take into account other daily expenses.

Another important note: your DTI doesn’t account for all of your monthly expenses such as taxes, groceries, gasoline, maintenance costs, and unexpected medical bills. Because of this, some experts recommend following the 28/36 rule. This rule states that your mortgage payment should not be more than 28% of your monthly pre-tax income, and all of your debt payments (including your mortgage) should not be more than 36% of your gross monthly income.

Potential refinancers

If your student loan debt was the only obstacle preventing you from refinancing into a new FHA loan, then it is worth checking out how much you can potentially save now. “For people looking to refinance, this is a home run,” says Garland. “If they have this income-based repayment plan, we can use that payment to help them qualify and now they can get refi and a lower interest rate.”

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

Before deciding whether an FHA refinance is the right option for you, compare the refinancing options you qualify for. Also, make sure you are around long enough for the potential savings to outweigh the cost of refinancing.