Help for FHA applicants with IBR loan payments
The Federal Housing Administration (FHA) has cleared the way for prospective homebuyers with student loan debt to more easily qualify for a home.
On June 18, the FHA — part of the U.S. Department of Housing and Urban Development (HUD) — announced changes to how lenders calculate student loan debt in borrowers’ debt-to-income ratios (DTI), a move that could mean millions of people have an improved shot at homeownership.
The announcement came a day before Juneteenth, which was recognized as a federal holiday for the first time this year. HUD Secretary Marcia L. Fudge acknowledged the anniversary in a statement and said the move is designed to address inequities in homeownership.
“As our country comes together to remember Juneteenth and acknowledge National Homeownership Month, we are reminded of a basic truth: that, too often in our history, the march toward freedom has been a long, halting, and uneven journey,” Fudge said in a statement. “Homeownership is the cornerstone of the American Dream and the best way to build generational wealth. … This new policy will make a big difference for individuals throughout our nation and is another step in our mandate to promote equity and opportunity for homeownership.”
The new FHA rules allow lenders to use borrowers’ actual monthly student loan payments if they are on income-based repayment (IBR) plans and their payments are more than $0, or 0.5% of their total loan balance to calculate their monthly debt-to-income ratio (DTI).
Previously, the FHA required lenders to use 1% of the total loan balance, regardless of a borrower’s monthly payment amount on an IBR plan.
The new guidelines could flip many buyers’ applications from “denied” to “approved” for low down payment FHA loans.
Here are the details.
What is the ‘Making FHA Work for Borrowers with Student Debt Act of 2021’?
The U.S. House Committee on Financial Services came out swinging in 2021 with proposed legislation to aid homebuyers in a historically competitive market.
In addition to a proposed $25,000 grant for first-time, first-generation home buyers, the Committee also introduced the Making FHA Work for Borrowers with Student Debt Act of 2021. It targeted loan applicants who are on income-based repayment plans and others making reduced payments on student loans.
According to Urban Institute, about 8 million people have income-driven repayment plans, representing about 30% of student loans.
That means the new legislation could make it easier for about 1 in 3 FHA homebuyers who are paying education loans.
“These changes remove unnecessary constraints for otherwise creditworthy borrowers and reinforce FHA’s ability to serve those who need us most, including first-time homebuyers and underserved communities,” Lopa Kolluri, principal deputy assistant secretary for the FHA, said in a statement.
The method: a small but significant tweak to how lenders calculate the student loan payment.
How the rule changes the student loan payment calculation
Prior to the change, FHA required lenders to qualify borrowers using a “worst case” student loan payment using the greater of either:
- One percent of the outstanding balance on the loan; or
- the monthly payment reported on the credit report
The lender was only allowed to use the actual payment when it was fully documented and the loan would be fully paid off by the end of the loan term at the current payment.
So those with deferred loans, income-based repayment (IBR) plans, Pay As You Earn (PAYE and REPAYE), Income-Contingent Repayment and Income-Sensitive Repayment plans were hit with a much higher payment than they would actually have had to pay. The payment amounts used under the old rule made it difficult for many prospective homebuyers to qualify for a mortgage because the calculated debt-to-income ratio was higher than their actual debt obligations each month.
The new rule changes that.
Now, lenders can use:
- The documented payment or payment amount that appears on a borrower’s credit report if the amount is greater than $0
- 0.5% of the loan balance if the payment amount that appears on the borrower’s credit report is $0
The changes could mean the difference between buying a house and continuing to rent for many would-be buyers in 2021.
A telling example
To further illustrate the impact, let’s look at how the previous “one percent rule” could be devastating for a homebuyer’s approval status.
Typically, FHA lenders allow about 45% of an applicant’s gross income to go toward monthly debts and future housing payment, though some will approve borrowers with a 50% or higher debt-to-income ratio.
In the below example, the applicant’s “real” student loan payment is $500. But, the lender discovers the applicant is on an income-based repayment plan. Her balance is $100,000.
If the lender must assume a $1,000-per-month payment (1% of $100,000) because the payment won’t pay off the loan in the stated term, her DTI could disqualify her from getting the loan.
|Current Rule||Proposed Rule|
|Future home payment||$1,500||$1,500|
|Car loans, credit cards||$700||$700|
|Qualifying student loan payment||$1,000||$500|
|Qualifying debt-to-income ratio||51%||43%|
Under the new rules, she would be more likely to receive an approval because the updated calculation puts her DTI well under the standard limits.
What about deferred student loans?
The FHA’s updates state that the new rules apply “regardless of payment status.”
But you still want to consider how future payment increases could affect your finances. A buyer could be put in harm’s way if he is paying $0 toward student loans now, but will start making considerable payments a few months after buying the home. Although a lender will account for a payment using the 0.5% rule, the reality of having to start making a student loan payment again and adjusting to a mortgage payment may be challenging.
Would this only affect FHA loans?
Yes, the new guidelines only change the rules for FHA loans. Fannie Mae, Freddie Mac, USDA, and VA loans would retain their various rules around student loan payment calculation.
When will the bill become law?
The new rules become mandatory as of Aug. 16, 2021. However, lenders may begin using the updated guidelines immediately to qualify creditworthy homebuyers.
Check your home buying eligibility
If you have student loans, you may qualify to buy a home even without this rule change.
At the very least, you will know where you stand and can make plans for the future.