Mortgage

How to turn renters into homeowners by beating student debt

Despite popular belief, options and strategies are available

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If you’re working with a first-time homebuyer under 40 years old, chances are good they are one of the 40 million Americans who still owe money on their student loans from college or graduate school. Much has been written about how student loan debt will turn the millennial generation into lifelong renters, but the truth is that the student debt problem is not nearly as big as many have portrayed it to be. Moreover, even if your client has significant debt, you can help him or her qualify for a mortgage.

For millions of older buyers, student debt is no big deal. According to the Federal Reserve, in 2010 the median balance of outstanding student loan debt was $13,000 — more than what many people owed on their cars. However, younger buyers in their early 30s and 20s might owe much more. In recent years, tuition costs have soared. Nearly 7 in 10 graduating seniors in 2013 — 69 percent — left school with an average of $28,400 in student loan debt.

Debt is not a good thing when it comes to getting approved for a mortgage. Lenders use the ratio of income to monthly debt payments to determine whether a borrower can repay the loan. Younger buyers, with lower income and significant student debt, will have a difficult time qualifying.

The qualified mortgage (QM) rule that took effect last year makes it even tougher. It sets a ceiling of a debt-to-income level of 43 for the back-end ratio for qualified loans, which means monthly debt payments can’t exceed 43 percent of income. But lenders are more conservative; the average DTI today is only 37 percent.

Buyers whose student loan debt is large enough to cause a problem might have options that they have never considered. Here are four ways to put them into a home:

1. Get forgiven.

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What could be better than never paying another penny on your student loans? Under certain conditions, borrowers can get their loans wiped completely clean.

There’s no reason for this generation to wait any longer. They’ve waited long enough for their first home."

Teacher loan forgiveness

If you are a teacher and did not have an outstanding balance on a Direct Loan or Federal Family Education Loan (FFEL) Program loan on Oct. 1, 1998, or on the date you obtained a Direct Loan or FFEL Program loan after Oct. 1, 1998, you could qualify to have up to $17,500 of your loans forgiven. For more information, see Teacher Loan Forgiveness.

Loan discharges

Loans can be discharged for total and permanent disability, bankruptcy, school closure before you could finish, false certification and other conditions. See Discharge Conditions.

Perkins loans

These low-interest federal student loans for undergraduate and graduate students are for exceptional financial need. These loans have additional discharge terms, including requiring applicants to be a volunteer in the Peace Corps, teacher, member of the U.S. armed forces (serving in area of hostilities), nurse or medical technician, law enforcement or corrections officer, Head Start worker and other requirements. See the Perkins Cancellation and Discharge Chart.

Public service vocations

If you have a direct loan and have made 120 payments (10 years’ worth) since Oct. 1, 2007, and during that time you have been employed in a public service job, such as teachers and medical personnel who work in low-income areas, public defenders, workers at certain nonprofit agencies and military personnel, you might qualify for forgiveness. Unfortunately, borrowers won’t be able to qualify until Oct. 1, 2017. For more information, check out the Public Service Forgiveness Program.

2. Check out income-based and pay-as-you-earn repayment plans.

Last year, the federal government announced several repayment options based on income. Income-based repayment plans adjust borrowers’ monthly loan payments to be no more than 15 percent of their “discretionary” income — the amount of money they make that falls above the federal poverty level.

Another plan, a pay-as-you-earn plan, caps monthly payments at 10 percent of a borrower’s disposable income, and it forgives the balance after 20 years of payments.

Since lenders’ debt-to-income ratios are based on monthly obligations, these programs could make a big difference in a homebuyer’s chances of getting a mortgage by limiting the monthly student loan payment. Here’s where you can find out more about repayment programs.

3. Manage total debt wisely.

For most student loan borrowers, their monthly student loan payments are not so large as to preclude them from getting a mortgage. For most who have been denied a mortgage, their problem was not student loan debt but total debt.

An analysis of unsuccessful first-time-buyer loan applicants with student loan debt by loanDepot found that the average unsuccessful applicant would have been approved with just $150 more in income or $150 less in monthly debt payments. A lower car loan, fewer credit card purchases, less entertainment — borrowers with student loan debt can manage these debts enough to get qualified for a loan.

Before applying for a mortgage, help your client calculate their debt-to-income (DTI) ratio based on their documented monthly income and their monthly debt obligations. Then help them reduce those until they reach a ratio that will get approved.

4. Use FHA.

Federal Housing Administration loans have been unpopular in recent years because of their soaring mortgage insurance premiums. Now that the annual payments have been cut in half, many young borrowers taking a second look at FHA, especially because its 3.5 percent down payment is hard to beat.

There’s another reason to take a good look at FHA. What few know is that FHA is a terrific option for high-debt borrowers because even though it has the same 43 percent debt-to-income as stipulated by the QM rule, FHA and FHA lenders are approving mortgages with much higher DTIs for borrowers with really good FICO scores. As a matter of fact, the average DTI for an FHA purchase loan last year was 47 percent, a full 10 percent above the average DTI for conventional purchase loans.

With the passage of time, millennials will find it easier to get financing as their incomes rise, and their student loan obligations shrink. But there’s no reason for this generation to wait any longer. They’ve waited long enough for their first home.

Steve Cook is editor of Real Estate Economy Watch, which was recognized as one of the two best real estate news sites of 2011 by the National Association of Real Estate Editors. From 1999 to 2007 he was vice president of public affairs for the National Association of Realtors and continues to provide communications consulting services. In 2006 and 2007, he was named one of the 100 most influential people in real estate.

Email Steve Cook.