Everything You Need to Know About Student Loans and Buying a Home

Written by Posted On Monday, 06 November 2017 12:33

There is a lot of focus right now about how student loans are impacting the real estate market, especially for prospective millennial home buyers.  Student loan payments can make it more challenging to save money for a down payment and qualify for a mortgage.  In fact, many younger potential first-time home buyers cite students loans as one of the main reasons they cannot afford to buy a home.  Although student loans certainly make it more difficult to buy a home, mortgage guidelines for student loans have actually become more flexible over the past year.  Read below to understand how student loans impact the home loan and home buying processes.          


How is Student Loan Debt Treated When You Apply for a Home Loan?

Under most circumstances student loan payments are treated like other types of monthly debt payments such as car loans and credit card bills.  Your monthly student loan payment is included as debt when the lender calculates your debt-to-income ratio to determine what size home loan you can afford.


From the standpoint of a borrower with student loan debt, the more money you spend on your monthly student loan payment, the less money you can spend on your home loan and other monthly housing expenses which reduces the size of the home loan you can afford.  This is why student loans can make it more challenging to qualify for a home loan.


Student loans can also make it more challenging to save for the down payment to buy a home, which is another consideration for borrowers.


What if My Student Loan Payment is Lower than What Is Outlined in My Original Loan Documents?

Many borrowers who are on income-driven repayment (IDR) plans make monthly payments that are lower than the monthly payment stated in your original student loan documents, including no monthly payment in certain cases. If you are on an income-driven repayment plan (IDR) the lender uses the lower monthly student loan payment you are actually making as long as that payment is reflected on your credit report or you provide loan documentation that verifies the plan and lower payment.


In the past lenders would use the payment outlined in your original student loan documents to calculate your debt-to-income which meant borrowers could not benefit from the lower payment they were actually making.  According to revised lender guidelines, the actual student loan payment you are currently making is typically included in your debt-to-income ratio which can make it easier to qualify for a home loan.  


What Happens if My Actual Student Loan Payment is Different than the Payment Stated on My Credit Report?

In some cases, the credit report for borrowers on income-driven repayment plans may not accurately reflect the current monthly student loan payment the borrower is making.  For example, the credit report may state the original, required student loan payment instead of the lower, income-driven required payment.  In this case, as long as you provide loan documentation that verifies the plan and lower payment, the lender uses the lower monthly payment.


How are Student Loans that are Being Deferred or in Forbearance Treated When You Apply for a Home Loan?  Do Lenders Exclude Them Because You are Not Making Monthly Payments?

Some people think that if their loan is being deferred or in forbearance then it is excluded from their loan application but that is not accurate.  Based on standard guidelines for conventional home loans, payments on students loans that are in deferment or forbearance are still included when you apply for a loan.  For deferred student loans or loans in forbearance, the monthly debt payment for the loan is calculated as either 1% of the outstanding loan balance or the full payment amount according to your loan documents.


The same general student loan rules also apply to FHA and USDA mortgages.  When you apply for an FHA or USDA loan, for student loans being deferred or in forbearance, the monthly debt payment used by the lender is the greater of 1% of the outstanding loan balance or the loan payment stated on your credit report.  The student loan rules for a VA Mortgage are a little more flexible and borrower-friendly.  As long as the student loan is expected to be deferred or in forbearance for at least a year after the mortgage, then the lender can exclude the student loan from the borrower’s debt-to-income ratio calculation.


Are There Any Ways to Exclude Your Student Loan Payments When You Apply for a Home Loan?

The only ways to exclude your student loan payments when you apply for a home loan are if your income-driven repayment plan does not require a monthly payment or if your monthly student loan payments has been paid in their entirety by a another party, such as a relative, for the prior twelve months.


If you are thinking about applying for a home loan in the future but do not have the funds to payoff your student loans then getting a helping hand from someone to pay your student loans for a year can improve your ability to qualify for a home loan.


Can You Take Cash Out When You Buy a Home to Pay Down Student Loans?

Aside from highly specialized, very unique loan programs, you cannot take money out when you get a mortgage to buy a home to pay down or pay off your student loans.  Some lenders enable borrowers to use a small portion of proceeds from a home purchase loan to pay off a portion of their student loans; however, these programs are highly unusual and typically limit the amount of proceeds you can use to pay off your student loans to $3,000.


A small number of state or local housing agencies may also offer student loan assistance when you purchase a home but these programs also typically impose significant restrictions such as buying a property out of foreclosure.

This article first appeared on FREEandCLEAR.  For more mortgage tools and resources please visit FREEandCLEAR.

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Michael Jensen

Michael H. Jensen is the co-founder of FREEandCLEAR, a leading mortgage website that enables borrowers to find the mortgage that is right for them.  FREEandCLEAR’s mission is to empower borrowers to make better mortgage decisions, save money and avoid getting ripped off.  To become an informed mortgage borrower visit www.freeandclear.com.


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