According to the Brookings Institute, about 42 million Americans (one in eight) have a student loan, totaling about $1.5 trillion in student loan debt. Only 30 percent of Bachelor’s degree recipients graduating in 2011-2012 managed to escape without a student loan; another 30 percent accumulated $30,000 or more in student debt. All this adds up to a whole lot of potential borrowers who have to navigate the added complexities involved with buying a house with student debt.
What’s Your Student Loan Repayment Plan?
If you have student debt, you probably were initially given a standard repayment plan. Many students, however, found quickly that they weren’t able to pay those payments reliably and risked default. For 8.1 million borrowers, not quite 20 percent of all student loan holders, those standard repayment plans were traded in for income-driven repayment plans. Although income-driven repayment was meant to help students successfully keep their loans in good standing, they also can create complications for getting a traditional mortgage.
Calculated Student Loan Payments
For students in anything besides a standard repayment plan, it may be necessary for a lender to calculate an estimated loan payment as part of the debt to income calculation, rather than simply using the number from the student loan holder’s documents. This is where the rub really comes in.
For some loan programs, a $14 payment in an income based repayment plan is just that, $14 added to the calculation. However, in others, because the income-based repayment plans are only approved one year at a time, a calculated payment is substituted. This, in theory, sets up a worst case scenario for lenders when it comes to the risk of foreclosure due to housing affordability. For student borrowers, it can turn a long awaited home purchase into a huge disappointment.
Loan programs typically calculate the estimated payment in one of two ways:
- By simply using the amount equivalent to one percent of the outstanding loan balance (if you owe $30,000, your monthly payment is figured at $300), or
- Calculating how much of a payment it would actually take to pay your loan in full in the term that remains (if you owe $30,000 and your term remaining is five years, your calculated payment would pay that loan off in full at the end of the five years).
This also goes for loans that are in forbearance or deferment, so there’s really no way around it.
Student Loan Payments and Debt to Income Ratios
If you’ve never had a mortgage before, or you’ve only had limited exposure to the lending industry, it’s important to understand how debt to income ratios work. Lenders determine how willing they are to loan to someone not only based on their credit worthiness, but also on how much other debt they have. They want to see that borrowers have plenty of financial wiggle room for emergencies, since they really don’t want to get the house back.
For most loans, that means a debt to income ratio (DTI) under about 43 percent. Anything you’ve agreed to pay over a longer term, like your student loans, are added into this calculation and compared to your actual income. When your car loan, student loan, rent or current mortgage payment, and credit cards are all combined, does that or does that not exceed 43 percent of your income? This is the first and most basic question. Various loan programs will have ways to compensate for high DTIs, to a point, and there are different DTIs for different programs, though generally they’re in the same ballpark. So if your DTI is high, it’s not yet time to panic. However, you should be cautious about your next move.
This is why, if you have large student loans, it’s even more important to carefully consider the debt obligations you’re taking on as you take them. Student loans aren’t the only hurdle, but they are definitely a very large one for many students. Imagine having 10 percent or more of your income suddenly discounted because your deferred student loans are suddenly counted against you, even if you don’t have to make a payment! That’s the situation some borrowers find themselves in when they go to apply for a mortgage they believe they’re ready for.
All Isn’t Lost, Many Lenders Will Help
The good news is that lenders can help you sort your student loan woes out, even if it takes a little time to get you on the right path. Not only can they help you understand compensating factors that could help stretch your DTI a bit higher, they can also point to financial moves you can make to decrease your DTI, such as paying off those loans in their last legs or finding a co-borrower who can help even things out a bit.