Getting an FHA mortgage with student loan debt
Can you qualify for an FHA mortgage even if you are saddled with thousands of dollars in student loans? Yes, but these loan payments complicate the decision and restrict the loan amount.
Student debt is far from rare among college graduates. The Institute for College Access & Success reports that seven out of 10 public and nonprofit college graduates had student loan debt in 2015. These debts amounted to an average of 30.$100 for each of these graduates.
If you make monthly payments on student loans, you may have difficulty qualifying for a mortgage insured by the Federal Housing Administration. That's unfortunate because FHA loans have one big advantage: they only require a 3.5 percent down payment, even for borrowers with FICO credit scores are as low as 580.
For many borrowers, that small down payment amount is crucial, which is why student loan debt can be such a problem for so many.
"Student loan debt is a real problem," said Justin Derisley, vice president of mortgage lending with the Troy, Michigan, office of Guaranteed Rate. "Student loans have become an important factor in determining the purchasing power for a home when factored into the debt-to-income ratio."
Debt to income ratio is important
Mortgage lenders want your total monthly debt, including estimated new mortgage payments, to be no more than 43 percent of your gross monthly income, d. h. Of your income before taxes are deducted. Lenders count your student loan payments as one of your monthly debts.
If your student loan payments exceed that 43 percent mark, you may not qualify for your mortgage. You may need to apply for a smaller mortgage instead to buy a less expensive home, or consider other types of mortgages besides an FHA loan.
New lending rules make it a little easier for borrowers with student loans to qualify for conventional mortgages, loans that are not insured by a government agency. The problem with this? The most important of these rule changes will not help borrowers applying for FHA loans.
A rule change that will not help
Earlier this year, Fannie Mae changed what it calls the 1 percent rule. When determining the average monthly student loan payments of their borrowers, lenders have traditionally used a figure equal to 1 percent of those borrowers' outstanding loan debt. The problem with this method was that this 1 percent payment could be higher than the actual amount borrowers paid each month on their student loans.
However, Fannie Mae's new guidelines allow lenders to use monthly student loan payments that are actually reported to the three national credit bureaus, Experian, Equifax and TransUnion. If the actual payment is lower than the 1 percent payment, this could lower a borrower's debt-to-income ratio, making it easier for that borrower to qualify for a mortgage.
Lenders making FHA loans, however, still have to follow the old 1 percent rule.
How the 1 percent rule harms
Consider this example: Let's assume borrowers have a student loan balance of 50.000 dollars, but take advantage of an income-driven repayment plan that lowers their monthly payments to $250. If these borrowers apply for a conventional mortgage that is not insured by the FHA, their lender could count the monthly student loan payment as $250. However, with an FHA loan, lenders still have to use 1 percent of the student loan balance as a monthly payment for these borrowers. In this example, the monthly payment would be $500, not $250.
If this additional amount raises your debt-to-income ratio above 43 percent, you may not qualify for a loan or may have to apply for a smaller mortgage.
This FHA idiosyncrasy also means that deferrals do not help borrowers. Derisley gives the following example: Suppose you come out of school with a solid job and hope to buy a house worth 250.000 dollars to be able to finance. Your loans have been deferred for three years, so you are not making payments now, but you owe a total of 100.000 dollars of student loans.
Instead of counting your student loan payment as zero dollars per month, your lender must count it as 1.000 dollars, or 1 percent of your total debt, count.
"This can push the debt-to-income ratio to a level where buying a home with an FHA loan is out of reach until the balance is reduced," Derisley said.
What you can do?
If your student loan debt is too high, you have a few options to qualify for an FHA loan.
First, you can wait to reduce your student loan balance, perhaps paying more each month to reduce the amount. If you reduce the balance, the 1 percent monthly payment will be lower and may not drive up your debt-to-income ratio
You can also work to reduce your other debts. For example, if you can pay off credit card bills, your minimum monthly credit card payments will be less. If you can pay off a car loan, those monthly payments no longer affect your debt-to-income ratio.
Finally, you can apply for either a smaller FHA loan or a conventional mortgage loan that is not insured by the federal government
Vishal Garg, founder and CEO of Better Mortgage in New York City, recommends borrowers who can't qualify for an FHA loan consider a conventional mortgage. Several Fannie Mae rules have made it easier for borrowers with high student loan debt to qualify for a conventional mortgage, Garg says.
"While FHA has been a popular option for those with higher debt ratios and a lower down payment, Fannie Mae has made some great strides in affordable lending, especially for those with student debt," Garg said.
This includes Fannie's HomeReady program, which allows a debt-to-income ratio of 50 percent and 3 percent down payment. Garg said Fannie launched this program as an alternative to FHA loans.
To review, remember that: 1. Your loan amount depends on your income & and outstanding debts. 2. When you reduce your debt, your debt-to-income ratio improves. 3. When applying for an FHA loan, it is important to make a down payment.