On the heels of our first-ever Agent Appreciation month, Inman is leaping into February with our Residential Finance theme month. Join us as we investigate how buying and selling a home is changing, from companies backing consumers in new ways to integrated services that handle the entire transaction.
Student loan payments, like other debt payments, are factored into an individual’s debt-to-income ratio, which mortgage underwriters consider when deciding whether to issue a mortgage.
Five federal institutions back about two-thirds of mortgages in the U.S.: Fannie Mae, Freddie Mac, The U.S. Department of Veteran’s Affairs (VA), the Federal Housing Administration (FHA) and the U.S. Department of Agriculture (USDA). However, as the Urban Institute pointed out, all five of these institutions have created separate ways of considering income-driven repayment plans when underwriting mortgages, a discrepancy which can easily perplex borrowers.
“These divergent methodologies create confusion and inconsistency and can disadvantage borrowers who end up with an FHA, VA, or USDA mortgage,” the study says.
“When the borrower has a fixed, standard loan payment, that monthly payment amount is generally used as part of the [debt-to-income] calculation. But if the loan payment is variable for any reason, like it is with [income-driven repayment plans], the way the loan payment affects the [debt-to-income] ratio varies by agency.”
For borrowers using income-driven repayment plans, Fannie Mae uses the monthly income-driven repayment amount when calculating their debt-to-income ratios, even if that amount is $0 due to a borrower having an income less than 150 percent of the federal poverty level. Freddie Mac also uses this monthly repayment amount, unless it is $0, in which case, they calculate 0.5 percent of the loan balance per month.
On the other hand, the FHA and USDA disregard the borrower’s monthly repayment amount completely, and instead, assume a payment of 1 percent. Meanwhile, the VA gives lenders the option of using the borrower’s monthly repayment amount or using 5 percent of the outstanding loan balance per year (leaving borrowers at the mercy of lenders).
As the sample table below shows, such divergent methods for choosing these monthly payment amounts can wildly affect an individual’s debt-to-income ratio.
The 11.2 percent difference between a Fannie Mae-calculated debt-to-income ratio and a USDA-calculated debt-to-income ratio could truly make or break someone’s ability to qualify for a mortgage, highlighting the need for consistency in these different mortgage lender policies in order to ensure a degree of fairness for borrowers.
Despite the clear disadvantage individuals with student loans face, first-time homebuyers are the most likely to receive loans from these entities.
“First-time homebuyers comprise 79 percent of FHA purchase loans, 84 percent of USDA loans, and 54 percent of VA loans, but just 42-45 percent of government-sponsored enterprise loans,” the Urban Institute reports.
Additionally, nearly one-quarter of federal student loan borrowers ages 25 to 34 use income-driven repayment plans, making a significant portion of a demographic likely to contain first-time homebuyers particularly vulnerable to receiving bad deals on mortgages because of their student debt repayment plans — which, in many cases, may be the only repayment plans they can afford.
Although the Urban Institute’s report was circulated on January 31 by Inside Higher Ed, whether or not it can make a wider impact on government mortgage lending remains to be seen.