How FHA Loans Handle Student Loan Debt

Can the new guidelines for student loans help me buy a house?

Students throwing their hats in the air upon graduatingYou're eager to buy a home, but you've been told in the past that your student loan debt will prevent you from qualifying for a mortgage. That may no longer be true following a recent change to the FHA student loan guidelines.

On June 2021, the U.S. Department of Housing and Urban Development (HUD) made it easier for more Americans to become first-time homebuyers by adjusting how it calculates student loan payments when determining a borrower's debt-to-income ratio.

New FHA Student Loan Guidelines Release on June 6th, 2021

The first major change to the FHA student loan guidelines was announced on June 6th, 2021. That's when HUD released the final guidelines for the 21st Century student loan guidelines.

The new guidelines change everything. Under the new student loan guidelines, mortgage lenders can use the borrower's actual student loan payment under an income-based repayment plan.

Previously, the FHA used 1% of the borrower's outstanding student loan balance for their debt-to-income ratio.

Now, lenders can use the borrower's actual student loan payment under an income-based repayment plan. The new guidelines also allow for a broader debt-to-income ratio for qualified borrowers. The qualifying ratio was lower before, and now includes debt from other sources.

Old FHA Student Loan Guidelines

The FHA calculates a borrower's debt-to-income ratio based on the borrower's total debt, including both their mortgage and student loan. The FHA then compares this amount to the borrower's income to decide if the borrower is “highly unlikely” to be able to make their loan payments.

Before the change on June 21, 2021, lenders had to take 1% of the student loan debt and use that as the monthly payment. 

For example, if the total amount of student loan debt is $30,000, then $30,000 x 1% = $300. Even if the actual payment was less than $300, the lender had to use $300 as the qualifying amount.

The problem with this formula is that the student loan calculation often made it hard for people to buy a home.

New FHA Student Loan Guidelines

The new FHA guidelines for student loans permit lenders to utilize either the actual payment as shown on a credit report if it is more than zero or .5% of the loan total. Examples of how to calculate student loan payment:

  1. Payment appears on the credit report.

    The student loan payment of $300 is reported on the credit report.
    Joyce owes more than $200,000 in student loan debt. The lender will use the actual payment amount shown on her credit report.

  2. Payment is not on the credit report.

    John owes $50,000 on his school loans, and his credit report does not reflect a monthly payment. When calculating John's debt-to-income ratio, the lender will utilize a payment of $250 ($50,000 X.5%).

  3. Payment $0 on the credit report.

    Kathy owes the federal government $70,000 in student loans. Her credit report does not list a monthly debt payment.

    Unless Kathy requests a recalculation of her monthly payment owing to a major change in income or family size, the lender will use $350 as her payment amount ($70,000 X .5%).

  4. Loan in deferment.

    Trudy is $100,000 in debt to the federal government for student loans. Her credit report indicates that her bills are deferred.

    After the deferral period expires, the loan officer will use a monthly payment of $500 until the loan servicer sends her a payment schedule indicating a reduced payment amount under an income-driven repayment plan.

Qualifying for an FHA Mortgage Just Got Easier

Caluculating student loan paymentThe difference between the old and new FHA guidelines can mean a big difference in how many home loans are approved. Before the change, the old student loan guidelines were too strict for many borrowers. The change has loosened the requirements, allowing more Americans to become first-time homebuyers.

In order to qualify for a mortgage loan, most lenders require that your monthly debt payments (including your mortgage payment) not exceed a certain percentage of your gross monthly income (usually 41%). This is known as your debt-to-income ratio. If your debt payments are too high, you may not be able to qualify for a loan.

The new guidelines also allow for a broader debt-to-income ratio for qualified borrowers. The qualifying ratio was lower before, and now includes debt from other sources.

Many young people take on student loan debt to maximize their earning potential. A borrower who has debt from medical school, graduate school, and law school can qualify for a larger loan amount with a high debt-to-income ratio.

The Different Types of Student Loan Repayment Plans

There are different ways to repay your student loans:

Fully Amortizing Payment Schedule

The completely amortizing payment plan is one in which your monthly student loan payments pay off the loan at the end of the term. Numerous student loans have 10-year payback terms.

This implies that if you make equal monthly payments for 10 years or 120 months, your student loan debt will be paid off.

Progressive Repayment Plan

A graded repayment plan has the same 10-year duration as the fully amortizing payment plan, but during the first one to two years, payments are reduced.

After the first one to two years, the payments will rise such that the loan is fully repaid within 10 years.

Income-Related Repayment Program

There are a variety of income-based repayment programs, but most of them have the same characteristics, which I will outline below.

Income-Based Repayment Plan

With an IBR repayment plan, you pay back your student loan depending on your current income level. This is normally between 10 and 20 percent of your predicted discretionary income, with family size is taken into account.

Because the majority of these payment plans are insufficient to properly repay the debt (or the quickly mounting interest), borrowers in this sort of program often get their student debt forgiven in 20 to 25 years.

Deferred Payment

If you are currently in school or have just graduated, you may be eligible to postpone your student loan payments. Deferment typically lasts till the completion of education or for three to four years following graduation.

It is crucial to note that interest continues to accrue on deferred loans, so use this option with caution.

Hardship or Forbearance

Hardship or Forbearance is when the lender permits you to temporarily halt payments on your student loans due to a life crisis. Typically, forbearance is permitted for up to 12 months, after which you must begin a repayment plan.

Why Are FHA Loans So Popular?

The FHA provides a very low down payment requirement for home loans. This means that you only need 3.5% down instead of the 20% minimum down payment required for conventional mortgages (Fannie Mae).

The FHA also allows for flexible credit requirements, which means that people with past credit problems can qualify for an FHA loan.

Easy FHA Loan Requirements

  • Primary residences only
  • A credit score higher than 580
  • No bankruptcies in the last 2 years and no foreclosures in the last 3 years, with re-established good credit
  • A monthly debt-to-income ratio under 43% 
  • Co-borrower or cosigner is allowed
  • Seller concession up to 6% of the purchase price
  • No reserve payments required

Conclusion

In conclusion, the new FHA student loan guidelines for 2022 should make it easier for borrowers to get approved for a mortgage. This is good news, especially given the current state of the housing market. If you are thinking about buying a home in the near future, be sure to check out the FHA student loan guidelines to see if you qualify.

SOURCE: Student Loan Payment Calculation of Monthly Obligation

Recommended Reading

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  3. FHA Home Loans: What are the Income Requirements?