One of the main tentpoles of the American dream is the hope of owning a home, complete with the white picket fence, red door, and two-car garage. However, for those of us with student loans, the road to home ownership is fraught with obstacles. Rising housing prices, tighter lending criteria, and the fact that massive student loan debt disproportionately impacts people of color means that many of us have found ourselves unable to start building the generational wealth that we crave through real estate because of the money we borrowed to obtain upward mobility in the form of higher degrees.
But, before you wring your hands in despair, know that there’s good news on the horizon all wrapped up in a recent change to how student loan debt is now calculated when reviewing a borrower’s eligibility for a home loan.
Debt-to-Income Ratio Vs Student Loans
One of the biggest factors used to calculate a borrower’s ability to successfully maintain and pay off their home mortgage is your debt-to-income ratio. Your debt-to-income ratio (DTI) compares how much you owe each month to how much you earn. Specifically, it’s the percentage of your gross monthly income (before taxes) that goes towards bills such as your rent, utilities, credit cards, car payments, and other debt. This is the formula mortgage lenders use to help assess your creditworthiness as a borrower.
Student loans are a huge factor in calculating your DTI and are calculated by dividing your monthly debt payments by your monthly gross income. This formula yields a percentage value that lenders scrutinize to evaluate your ability to repay a mortgage.
Until recently, if your loans were deferred or were being paid under an income-based repayment plan (IBR), Federal Housing Administration (FHA) mortgage lenders calculated a borrower’s monthly student loan payment as 1% of their total loan balance. This meant that even if the actual monthly payment was significantly lower or even $0, the lender still had to apply 1% of the total amount of the entire loan balance to the borrower’s DTI. And since the higher a borrower’s debt, the harder it is for said borrower to qualify for a mortgage, this policy made it an uphill climb for many borrowers with student loan debt to qualify for their first home.
The Good News…
In recognizing that the old policy unfairly prevented many borrowers of color from attaining the dream of home ownership, the FHA announced updates to its student loan monthly payment calculations earlier this summer. In an effort to remove barriers and provide more access to affordable single-family, FHA-insured homes, the new FHA policy allows mortgage lenders to use a borrower’s actual monthly student loan payment amount, even if it is below the traditional amount of 1% of the total balance. And if a student loan borrower’s calculated payment is $0 (which is possible under an income-driven repayment plan), the mortgage lender will automatically apply 0.5% of the outstanding student loan balance as an assumed payment, rather than 1%.
How does this affect you?
The decrease in the DTI ratio is significant and can make a big difference in qualifying potential. The change can also affect how much one can borrow too. Lowering one’s DTI also increases their homebuying purchasing power.
To determine if the new rules increase your ability to secure a mortgage, you can check out one of the many online resources such as this one or speak speak with a trusted local mortgage lender.