You graduated college and have a great job. It is time to buy a home! As you look at your finances, you see that you can afford a mortgage payment. You may even calculate 28% of your gross monthly income to determine how much house you can afford. There is one problem if you have student loans, though. If you have income-based repayment plans for student loans, Fannie Mae has strict guidelines on how you qualify.
Income-based repayment plans allow you to lower your student loan payments to an affordable level. The amount you pay depends on your income. The lender runs an evaluation annually to determine your payment. If your income is low enough, you could even pay nothing on the loan for the year. However, you do have to pay the loan at some point, unless you want your student loans haunting you when you are retired! Because of this, Fannie Mae has guidelines to help determine if you qualify for a mortgage with the student loans.
Fannie Mae’s Rules about Repayment Plans
Fannie Mae requires lenders to include some type of payment in the debt ratio. This means even if you do not owe monthly payments right now, the lender must include something. This is in an effort to make sure you can afford the mortgage in the future, when your student loan payments begin. It seems like Fannie Mae just makes it harder to qualify for a loan, but they just want to protect borrowers. There is nothing worse than feeling house poor or worse yet, defaulting on your mortgage and losing your home.
The old school way to determine a payment amount was to use 1% of the loan amount. However, this was slightly unfair to borrowers. Let’s look at a borrower with $100,000 in student loan debt.
At 1% of the balance, he would have a $1,000 monthly payment included in his debt-to-income ratio. This is too high for most people to qualify for a new loan.
Today, Fannie Mae allows lenders to do any of the following:
- Use the fully amortized payment as stated on their loan documents. This is not always easy to find, though. Sometimes you can ask the lender for the amount or it reports on the credit report.
- Use a calculated payment based on the current interest rates and the terms stated in the loan documents.
- Use a calculated payment based on the standard repayment terms for the amount of the loan
No matter which way you look at it, Fannie Mae requires lenders to use a fully amortized payment. However, this is better than the 1% rule. For example, on the $100,000 loan, the standard repayment period equals 30 years. This allows the lender to amortize the payment over 360 payments. The payment will usually be lower than the 1% or $1,000.
Debt Ratio Requirements
Every lender has different debt ratio requirements. However, today thanks to the Qualified Mortgage Rules, no loan can have a debt ratio that exceeds 43%. This is another reason the income-based repayment plans for student loans greatly impact your loan eligibility.
For example, if you make $60,000 per year, your gross monthly income equals $5,000. This means your total monthly expenses may not exceed $2,150. If you had to use the 1% rule on the student loan, that would take away $1,000 of the $2,150 right off the bat.
Instead, however, you can use the actual or calculated payment. Using today’s rates, the average interest rate would equal 4.29% on a 30-year term. This makes the student loan payment $494. If you have other minor debts, such as credit card debts of $150. You would have around $1,500 left for a housing payment.
This does not mean you have to borrow as much as you qualify to receive, though. You should only borrow what you can comfortably afford. Since you are on the income-based repayment plans for student loans, you probably cannot afford a large payment right now. Aside from that, you have to figure your student loan payment will increase in the future. It may not be right away, but it will happen. You want to minimize the amount of payment shock you experience. Making yourself “house poor” could make things difficult. You may find you either have to sacrifice or let your home go into foreclosure. Neither option is very pleasant!
When you are ready to purchase a home, use a lender that understands student loans. Not only is your approval in their hands, but your future is too. If they qualify you for a loan you cannot afford, you may face financial difficulties. However, if they do not calculate your payment the right way and use the 1% method, you may be without a loan approval.
If you know your income-based repayment plans for student loans payment reports on your credit report, you may want to use a Freddie Mac program. These loans are also conventional loans. You still get great interest rates and terms. The difference is who backs the loan. A lender who understands the process will recognize your ability to use a Freddie Mac loan. You still need a debt ratio under 43%. The difference is Freddie Mac allows lenders to use the IBR payment on the credit report. Fannie Mae does not allow this. Fannie Mae only allows fully amortized payments or the 1% rule.
Keep in mind, if you use the IBR payment to qualify, you should have an idea of the fully amortized payment. This helps you plan for the future. If you stick to the 43% rule, you should comfortably have room for a higher payment. But, no one can predict the future. You do not know if your income will increase or decrease down the road. Eventually, you have to pay off your student loans, which means paying principal and interest. Know what that payment might look like so you can plan accordingly. It is always easier to upgrade your housing rather than downgrading. Start small and see what you can afford!