From Debt to Dream Home: Navigating Student Loans on the Path to Homeownership

With the pause on federal student loan payments expiring, the topic of student loans is on many lenders’ minds. Aspiring homeowners may be also curious about how their student loan debt may affect their mortgage eligibility.

Contrary to some borrowers’ assumptions, it’s possible to qualify for a mortgage while carrying student loan debt. Applicants’ eligibility ultimately depends on their chosen loan program, debt-to-income ratio (DTI), and credit score.

Since so much is happening in the student loan space, it’s important for mortgage lenders to stay up-to-date and keep their applicants informed. In this article, we’ll review the latest guidelines for getting a mortgage while paying off student loans. We’ll also highlight some ways that lenders can help student loan carriers qualify for mortgages.

When Are Federal Student Loan Payments Resuming?

This year, over 43 million people have outstanding federal student loans.^[i] Since March 2020, these loans have enjoyed interest-free forbearance. However, this long pause is quickly coming to an end.

Starting September 1st, 2023, federal student loans will begin accruing interest once again. Full monthly payments will resume on October 1st, 2023.

How Do Student Loans Impact Mortgage Eligibility?

With student loan payments re-starting, many borrowers may be wondering if they’re still in the right financial position to purchase a home. You can help them make the right home-buying decisions by educating them on the relationship between student loans and mortgage readiness.

Student loans can affect the following mortgage eligibility criteria:

#1 Debt-to-Income Ratio

DTI is one of the most critical factors considered during the mortgage underwriting process. It compares an applicant’s recurring monthly debts to their gross monthly income. In turn, it gives underwriters an idea of whether or not an applicant can afford a monthly mortgage payment.

While lenders’ DTI requirements can vary, the general guidelines for mortgage programs are as follows:^[ii]

- Conventional – 36% to 43% (preferred), 45% to 50% (maximum)
- Federal Housing Administration (FHA) – 43% to 50%
- Veterans Affairs (VA) – 41%
- United States Department of Agriculture (USDA) – 41% (up to 46% in some cases)
- Jumbo – 36% (preferred), 43% (maximum)

As a recurring debt, student loans can directly affect borrowers’ DTIs. In some cases, student loans may push their DTIs past the acceptable limits and derail their mortgage eligibility. However, it’s important for borrowers to note that their monthly student loan payments aren’t always calculated the way they may think.

Monthly Student Loan Payment Calculations By Loan Program

A borrower’s student loan payment status (active, deferred, forbearance, or forgiven) can alter how mortgage underwriters calculate their DTI’s monthly payment amount.

Here are each loan program’s monthly payment calculation guidelines for student loans:^[iii]

- Fannie Mae calculates student loan payments in one of two ways. If an applicant’s student loan payments are listed on their credit report or student loan statement, Fannie Mae can use that monthly amount. If their loans are deferred or in forbearance, Fannie Mae will use 1% of the remaining balance or one payment from their loan repayment plan.
- Freddie Mac and the FHA work similarly to Fannie Mae. They both use the listed student loan payment amount on the applicant’s credit report or student loan statement. If there is none, they will use 0.5% of the outstanding student loan balance instead.
- VA looks at the higher amount of the following two figures: the student loan payment listed on the applicant’s credit report or student loan statement or 5% of their outstanding balance divided by 12. The only exception applies to deferred student loans—these loans aren’t considered during the VA loan underwriting process.
- USDA uses the loan payment amount on the applicant’s credit report or student loan statement unless no payment is recorded. In this case, it calculates 0.5% of their remaining balance or the monthly payment amount listed in their current repayment plan.

No matter the loan program, student loans that have been forgiven won’t be included in DTI calculations. Applicants simply need to provide documentation verifying their loan forgiveness.

Additionally, Fannie Mae and Freddie Mac won’t include student loans that are scheduled to be paid off or forgiven within 10 months. Likewise, VA loans won’t factor in student loans that are deferred at least 12 months after the mortgage’s closing date.

Help Your Borrowers Lower Their Recurring Debt

If one of your applicants has a DTI that’s too high, you can advise them on the best path forward. Some suggestions may include:

- Enrolling in an income-driven repayment plan – Income-driven repayment plans cap borrowers’ federal student loan payment amounts to 10% to 20% of their discretionary income.^[iv] After 20 to 25 years, these borrowers can have their remaining balance forgiven. In some cases, enrolling in an income-driven repayment plan may lower applicants’ DTIs enough to help them qualify for a mortgage.
- Extending their loan term – Another way that borrowers can reduce their monthly student loan payments is by consolidating or refinancing their student loans. If they receive a longer loan term, their remaining balance can be spread across a longer span of time, leading to lower monthly payments. Just make sure your applicants understand how loan consolidation or refinancing can affect their interest rates beforehand.
- Paying off other debts – Student loan payments aren’t the only debts that are factored into DTI. Credit cards, auto loans, personal loans, child support, alimony, and co-signed loans are as well. Thus, you can encourage your applicants to pay down whatever debts they can in the pursuit of a lower DTI.

#2 Credit Score

In addition to DTI, an applicant’s credit score is taken into careful consideration during the mortgage underwriting process. Student loans can affect applicants’ credit scores in a variety of ways. On-time payments can bolster their credit scores, while missed or late payments can drag them down.

Beyond that, late student loan payments can result in immediate mortgage denial. That’s because some government-backed loan programs require a Credit Alert Verification Reporting System (CAIVRS) check, which examines if an applicant has any delinquent federal debt.^[v]

If one of your applicants is denied due to delinquent student loans, you can suggest that they promptly take one of the following actions:

- Pay off their late payment
- Apply for loan deferment or forbearance
- Modify their repayment plan to make it more affordable

Coach Your Applicants Into Higher Credit Scores

Delinquent student loan payments aren’t the only thing that may be bringing down your applicants’ credit scores. Some applicants may be ineligible for a mortgage due to excessive credit card debt, insufficient credit history, or recent bankruptcies.

You can help these borrowers identify the most impactful steps they can take to improve their credit scores with the help of Certified Credit’s credit score improvement tools.

You can also share educational content about credit online in the form of blog articles, white papers, videos, and podcasts. This way, potential applicants can work on their credit scores before they apply with you. Our experts recommend sharing these resources with your borrowers:

- First-Time Homebuyer Guide: Empower your first-time mortgage borrowers to enter the housing market with the confidence, support, and trust they need!
- What You Need to Know As a First-Time Home Buyer: Helpful tips that can make purchasing a home easier and more affordable.
- How to Build Credit with No Credit History: Seven of the best ways to build credit and advice for boosting credit score quickly.

#3 Down Payment

With student loan payments resuming, many people may not be able to save as much money as they could during the past few years. In turn, coming up with an ample down payment may be more challenging.

Fortunately, many loan programs accept down payments well below the 20% standard. Here are the down payment minimums for the following loan programs:^[vi]

- VA – 0%
- USDA – 0%
- Conventional – 3%
- FHA – 3.5%
- Jumbo – 10%

By educating your borrowers on these down payment minimums, you can empower them to purchase a home sooner than they expected.

What About President Biden’s $20,000 Loan Forgiveness Program?

President Joe Biden announced that he would forgive up to $20,000 in federal student loan debt for any borrower earning less than $125,000 a year. However, this bill was blocked by the Supreme Court on June 30, 2023.^[vii]

Biden has since announced that he plans to pursue an alternative debt cancellation plan—this Plan B would utilize the Higher Education Act (HEA), as opposed to the Heroes Act.^[viii] The HEA authorizes the Secretary of Education to “compromise, waive, or release” federal student loans. Since this Plan B has yet to be fleshed out, mortgage lenders and student loan borrowers alike will have to stay tuned until further notice.

Certified Credit: Qualify More Borrowers Today

As you can see, student loans can impact borrowers’ mortgage eligibility in many ways. In today’s lending environment, the key to success is finding ways to say “not yet” instead of “no” to your non-qualifying applicants. By nurturing these applicants into a position of mortgage eligibility, you can boost your business and earn their enduring loyalty.

Here at Certified Credit, we offer many tools and educational resources that can assist with this process. In addition to our credit score improvement tools, we offer:

- Sharable educational resources, such as our First-Time Homebuyer’s Guide
- Automated borrower retention and lead generation tools
- Automated prequalification
- Automated verification of income and employment
- Automated undisclosed debt monitoring
- Affordable credit reports
- Flood zone determinations
- Fraud and risk support
- Settlement services