Jenny hung up the phone, relieved.
As I answered her call I could feel the tension in her voice.
She relayed that she was under contract to buy a home, but the mortgage loan was just denied in underwriting due to her student loans. Jenny said she had $120,000 in student loan debt that was on an Income-Based Repayment (IBR) plan with payments of $43 per month. But the underwriter was counting 1% of the balance, or $1200 per month, in her debt ratio calculation. And that pushed her debt ratio too high to qualify for the $300,000 home she was under contract to buy.
Jenny’s Realtor recommended that she reach out because we’ve closed similar loans together.
I’m glad she did.
We helped Jenny successfully close on her home and move in.
I get similar calls several times a month. And I am always happy that we can help. But let’s explore the rules around student loan debt with various types of home loans, just to set the record straight.
Fannie Mae Student Loan Guidelines
Fannie Mae sets guidelines for underwriting standards for Conventional Loans and has very specific rules for how to count student loan debt.
If the student loans are on an Income-Based Repayment (IBR) or Income-Driven Repayment (IDR) plan, then lenders are only going to count that IBR payment in your debt ratio calculation. That is true even if the payment is $0 per month. The same is true if the student loans in on a debt forgiveness plan.
We do still need to get an automated approval for the loan through Fannie Mae’s automated underwriting system, Desktop Underwriter (DU).
And so long as we get the automated approval, then we calculate the debt ratio using only the IBR payment. And conventional loans require 3% down payment for first-time home buyers, 5% down payment for move-up buyers.
If the student loans are deferred or in forbearance, then lenders are required to count 1% of the outstanding balance in the debt ratio calculation.
And that makes sense when you think about it. If the loan is deferred or in forbearance, then the lender has no way to know what that payment will be once it comes out of deferment and payment is due. So, when the monthly payment is known and documented, we can use just that amount in the debt ratio calculation. When it is unknown, then we have to assume at some point there will be payments due, and the safe calculation is 1% of the balance of the loan.
Freddie Mac Student Loan Guidelines
A Freddie Mac loan is also considered a Conventional loan; and much like Fannie Mae, it must get an automated approval through their automated system, LPA (Loan Product Advisor). And, similarly, it requires 3 to 5% down payment.
Regarding student loans, if the loans are on an IBR payment that is greater than $0, then that payment is used to calculate the debt ratio. If the student loan IBR payment is $0, then Freddie Mac will defer to using .50% of the outstanding balance in the debt ratio.
Similarly, if the student loan is deferred or in forbearance, Freddie Mac instructs lenders to count .50% of the balance in the debt calculation.
And as many student loans were in forbearance this year, once out of forbearance the borrower has to have made three consecutive payments prior to closing on the home loan.
Worth mentioning, if the student loans can be documented to be in a forgiveness program, then the underwriter does not need to count any payment in the debt ratio calculation.
FHA Loan Student Loan Guidelines
[Update: June 2021]
FHA would not allow IBR payments to be used – until this recent change from June 17, 2021.
Lenders now have the option of using the IBR payment on student loans to qualify for an FHA loan, so long as the IBR payment is greater than $0. Otherwise the lender can use .5% of the balance of the student loan to qualify.
After August 16 of this year, that becomes the FHA underwriting standard, and no longer optional.
I will tell you – it has already made a big difference.
We have been doing home loans for homebuyers with student loans on IBR payments for a long time; but we did have several that we could not get approved for a Conventional home loan, for various reasons.
With this FHA change for homebuyers with student loans, we went back through and have been able to issue pre-approvals for nearly a dozen buyers, who are now confidently shopping for their homes.
Good for HUD for changing to rules to favor home buyers getting approved for an FHA loan, even with student loans.
VA Loan Student Loan Guidelines
VA loan guidelines are a little different when it comes to addressing student loans.
If the student loans are deferred for at least 12 months past closing on the home loan, then no payment is added to the debt ratio calculation.
If the student loan is deferred less than 12 months past the home loan being closed, then the documented payment once it is out of deferment is used. And, if a payment is not able to be documented, the underwriter will use 5% of the balance, divided by 12. For example, for a $100,000 student loan balance:
$100,000 x 5% = $5,000/12 = $416.67/month
USDA Loan Student Loan Guidelines
As in the other loan types above, if the student loan is on a fixed payment, fully amortizing plan, that payment can be used.
As for IBR payments, they generally cannot be used. USDA requires that the amount used in the debt ratio calculation be the greater of the actual documented payment or .50% of the outstanding balance.
Also of note, this is the only loan type, so far, that will not allow the borrower to exclude student loans that are on a forgiveness plan.
USDA, also called Rural Housing loans, do not require a down payment. So, if the .5% of the balance works in your debt ratio calculation, and you want to move out to a more rural area (because you can work from home now…) then this is a good loan option to look at.
Jumbo Loan Student Loan Guidelines
A jumbo loan is any mortgage loan over $510,400 – at least for most of the County. And these loan guidelines are written by each investor or lender, since they are not government-insured loans like FHA, VA, and USDA loans; and are not sold to Fannie or Freddie.
Generally, the fully amortizing payment is used, or 1% of the outstanding balance if a payment is not being made.
Portfolio loans are similar, with guidance on student loans being determined by each lender.
With both portfolio and jumbo loans, there can be some flexibility in how they are counted when there are compensating factors such as ample reserves, low loan-to-value can credit history. An experienced loan officer can quickly help you determine your eligibility for these loans.
Every loan option treats student loan debt a little differently. An experienced loan officer familiar with helping home buyers successfully buy homes when they have student loans can navigate this world quickly with you.
My team and I have helped dozens, if not hundreds of home buyers with student loans into homes. We would love to help you. And, don’t be discouraged if another less experienced loan officer may have told you that your student loans will keep you from buying a home. Like Jenny, we would like to help show you your options for successful homeownership.