If You Have Student Debt, These FHA Qualification Changes Effect You!
Thanks to recent changes, FHA loans with student debt are going to be more accessible to many borrowers.
The amount of debt you owe every month is vastly important to lenders. Obviously, they want to know how much you make every month. But they also want to know how much you owe in monthly debt payments.
If two borrowers have the same income, but one has $1,000 in monthly debt while the other has no payments, they present two very different situations to a lending agent. The higher your monthly payments, the more risk you present to lenders and the less likely you are to secure financing, at least financing with generous and affordable terms.
Most debts are easy to apply to a borrower’s debt-to-income ratio. If a person has a $300 monthly car payment, you simply add $300 to their monthly debt total.
However, what if a person has $150,000 in student loans but are not actively making payments because the loans are in deferment? This makes the calculations a bit more complicated.
For years, the FHA had a strange system for calculating debt totals related to FHA loans. The calculation, as we’ll show, simply didn’t match reality and made it next to impossible for someone with student loans to secure an FHA mortgage.
But the rules are changing. Thanks to some basic adjustments, FHA loans are now far more accessible to anyone with student loans.
Changes for Getting FHA Loans with Student Debt
The old system was rather confusing, and essentially overestimated how much student-loan holders had to pay every month.
Prior to the most recent changes, if you had student loans that were in deferral, the FHA would use 2% of the loan balance as your assumed monthly payment on the application. So if you have $100,000 in total student loans, your application would basically say that you pay $2,000 every month.
Even for people with “average” student loan debt, the amount could be staggering. By some estimates, the average student loan debt amount is roughly $37,000. At 2%, this would mean about $750 is listed as your debt payment; when lenders and lending algorithms see a $750 payment, it can mean a significant issue if you are trying to get approved for a loan.
Eventually, the FHA realized this system was not practical, so they made changes. Unfortunately, these changes, while an improvement, were still far from ideal. The round of changes allowed lending agents to qualify a loan using student loan totals in one of three ways:
- The first option was to allow 1% of the outstanding balance, which would equal $500 for every $50,000 in student loans. This was half the amount used before, but still an over-estimate of the totals.
- The second option was processing the monthly payment on the credit report. While better, this was slightly inaccurate, as the credit report may not hold an accurate number. Even if the number was accurate, the monthly payment may change.
- There was also a third option. Lending agents could use the actual documented payment if that payment will be fully repaid over a specific term.
All of these solutions are better, and likely more of a true reflection for what someone would be paying if they have student loans. But the big issue was when these loans were in deferment.
Even under the second scenario, the borrower would essentially quote 1% of the loan balance as their monthly payment, which would mean if you have $100,000 in student loans, you have to claim a $1,000 monthly payment. This could create clear problems for your debt-to-income ratio when it comes time for the application.
Further change was needed. Fortunately, the FHA, or more specifically the Department of Housing and Urban Development (HUD) that oversees the agency, was paying attention.
A New System for FHA Loans with Student Debt: 0.5%
Under the new system, which will start in August of 2021, you can now use 0.5% of your loan balance as your monthly payment on the application. That reduction of a half a percentage might seem minimal, but it could open FHA loans, which have excellent advantages, to many people.
Let’s pretend you have exactly $100,000 in student loans that are currently in deferment. Let’s also suppose you have a monthly income of $6,000.
Under the original system, you would have had to claim $2,000 in monthly payments. This would mean that, as far as your application is concerned, your student loans are consuming roughly a third (33.33%) of your income. If you have car loans and credit card debt of any type, your ratio could easily skyrocket to above 50%.
Now suppose we have the same situation but use the second option. Under this scenario, you would have had to claim 1% of your $100,000 as a monthly payment. Your application would state a monthly payment of $1,000. Not bad, but that’s still roughly 17% of your income. Again, with car loans and other debts, your stated debt ratio could appear tight.
But with only 0.5%, which is the new option, you’ll have a much better DTI on your application. Under this new system, you would only have to claim $500. With a $6,000 income, this would translate to roughly 8.33%. There is still the chance to go over with other debts, but it creates much more breathing room for your finances.
These changes are important because they make FHA loans more available for a wide variety of potential borrowers. FHA loans are not always the right choice, but with low downpayment requirements and fairly light qualification standards, they can be an ideal option for your home-buying needs.
In many cases, homeowners can secure an FHA loan with as little as 3.5% down, which makes the point of entry much more attainable.
Get the FHA Loan You Deserve, Even with Student Loans
FHA loans are a great choice for many buyers. If you have student loans and are worried that you may not qualify for an affordable mortgage, contact our staff. We’ll help you get the right financing for these top-quality loans.