The Difference is in the Details
Mortgage Loan Options to Outsmart Student Debt
Don't let student loan debt crush your dream of homeownership! It's commonly known that owning your own home is one of the smartest financial decisions you can make, but are you worried that you won’t be able to because of your student loan debt? Student loans are definitely a drag, but they don’t have to prevent you from buying a home. You just have to use a Realtor® and a Lender that know how to work with them! We appreciate working with Daniel Schneider, Senior Loan Officer at Starkey Mortgage, because he is really knowledgeable about the different loan products and how each of them consider student loan debt. Daniel does a great job of educating our clients on those differences and then helps them decide what option is right for them.
There are two types of home mortgage loans that most people would consider when buying a home- the FHA Loan and the Conventional Loan. The FHA loan was historically thought of as being the first-time buyer’s loan. However, Daniel points out that the FHA loan is quite strict when considering student loans, “all student loans must be included in the borrower’s liabilities, regardless of the payment type or status of payments.” It seems pretty counterintuitive for FHA standards to be really strict regarding student loans considering that most first-time homebuyer’s are still paying off student loan debt. So, we’re here to help you understand and work around this obstacle.
The two major benefits of an FHA loan are that you only have to have a 3.5% down payment on the home, and that the minimum credit score required is generally lower than the conventional requirement. The downside to an FHA loan is how they calculate your monthly student loan payment. Daniel says technically the monthly payment can be calculated a couple different ways, “the greater of 1% of the outstanding balance on the loan; or the monthly payment reported on the Borrower’s credit report; or the actual documented payment, provided the payment will fully amortize the loan over its term.”
Unfortunately, most buyers fall under having to use the first method, calculating the monthly payment based on 1% of the school loan balance. This is whether or not you have an income-based monthly payment. Since income-based monthly payments are revaluated each year, they can increase each year. The FHA does not like this possibility, and therefore defaults to assessing your monthly payment as 1% of the debt balance. 1% may not sound like much, but if you have a $50,000 student loan balance, then it would be assumed that your monthly payment for that debt is $500.
The assumed monthly payment is not the whole story. A major factor in your eligibility for a home loan and your purchase price limit is your Debt To Income (or “DTI”) ratio. This is figured by looking at your monthly net income and the amount you pay monthly for your debts. So, an estimate of what your new mortgage payment will be, and then any recurring monthly debt payments. The FHA DTI maximum is 50%. Let’s say you bring home $2,500 each month after taxes, and that your new mortgage payment is going to be around $1,000. Now, you can see that if your student loan payment is assumed to be $500 each month, that’s already accounting for 20% of your DTI, and by the time you add in your mortgage payment you are over the maximum and looking at a 60% DTI! This is not to mention adding on any other monthly recurring debt payments like credit cards or vehicle loan payments.
Going with an FHA loan while having student loan debt is certainly possible for those that owe a relatively low balance on their student loans, or if your income is relatively high, but for most people that have student loan debt it’s going to be better to go with a conventional loan.
The reason that doing a conventional loan is easier when you have student loan debt is that your monthly student loan payment can be based on what you truly pay, not 1% of the balance. Daniel says that in the case of a conventional loan, “if the credit report does not identify a payment amount (or reflects $0), the lender can use either: 1% of the outstanding balance; or a calculated payment that will fully amortize the loan(s) based on the documented loan repayment terms.”
Conventional loans usually require a minimum down payment of at least 5% of the purchase amount of the home, and generally have a higher minimum credit score requirement than with FHA. Another benefit to a conventional loan is that the maximum allowable DTI is higher. So, let’s look at the same scenario of someone that nets $2,500 in income per month. If your monthly student loan payment is $100, and your new mortgage payment is around $1,000, then your DTI is 44%, which with a good credit score will be much more acceptable!
There are many other factors to be considered when being approved for a home mortgage loan, but we hope this has helped to illustrate the way student loans are factored into the process. If you have any questions please don’t hesitate to contact us, or Daniel Schneider at Starkey Mortgage. We look forward to helping you find your home!
Tracy Evangelista, 843.442.4278 or firstname.lastname@example.org
Lara Schellenger, 843.822.8895 or email@example.com
Daniel Schneider, Starkey Mortgage, 843.352.5824 or firstname.lastname@example.org