Student Loans May Affect Mortgage Eligibility

Betsy Mayotte

Paying off your student loans is just one of the competing financial goals many consumers are required to juggle. Another is home ownership.

It's pretty clear that your student loan payments are going to affect how much and how quickly you're able to save a down payment for your first home, as well as the affordability of your mortgage payments. But they can also affect your eligibility for the mortgage in the first place.

Take a look at the following to see how the different federal mortgage programs view the various types of student loan payments.

FHA Loans

Created in the 1930s, a Federal Housing Administration mortgage is a popular choice for many first-time homebuyers. Not only does it often allow for a lower down payment -- 3.5 percent in some cases -- the credit criteria can be a little more forgiving than one from a traditional lender.

Unfortunately, recent changes to FHA mortgage underwriting rules may make this option less available to consumers with student loan debt. In the past, consumers who had their student loan payments deferred for at least 12 months could exclude this debt from the overall debt-to-income ratio considered when applying for a mortgage.

What lenders look for here is whether your monthly debts are so high compared with your income that you are likely to struggle or be unable to pay your mortgage payment down the line. Most lenders look for debt-to-income ratios lower than about 43 percent, but some are OK if it is as high as 50 percent.

For borrowers with large student loan debt, having the option to exclude this debt from that debt-to-income calculation could mean the difference between being approved for an FHA mortgage and being denied. Since Sept. 14, however, such deferred loans will now be included in the debt-to-income calculation to the tune of 2 percent of the student loan amount or about $200 for every $10,000 owed.

This includes situations where the borrower is under an income-based repayment plan with a payment of zero dollars. Borrowers with fixed monthly payments will have those payments used in the debt-to-income formula.

While this rule change will certainly cause some first-time applicants to be denied, it will also help ensure that consumers are not taking on more debt than is manageable.

[Test your knowledge with this quiz on student loan repayment.]

VA Loans

Veterans Administration loans work under similar guidelines; however, they will not count the student loan debt if the loan is in an 18- to 24-month deferment at the time of closing.

Anecdotal evidence seems to indicate that underwriters sometimes use the same standards for both FHA and VA home loans, so it's always a good idea to ask how a deferred or zero dollar income-based repayment amount will be treated.

[Get familiar with private student loan repayment options.]

USDA Loans

Department of Agriculture home loans will take into account 1 percent of the balance of the loans in cases where the loans are deferred or under an adjustable repayment plan such as income-based repayment. If you are on a standard, nonadjustable payment plan, that is the amount that will be used in the debt-to-income calculation.

Most traditional mortgage writers use Fannie Mae's underwriting standards. These standards have also recently changed, but for the homebuyer's benefit. These new standards require that the greater of 1 percent of the student loan balance or the actual payment amount be used when determining applicants' debt-to-income ratio. Up until recently, the amount used was 2 percent.

Betsy Mayotte, director of regulatory compliance for American Student Assistance, regularly advises consumers on planning and paying for college. Mayotte, who received a B.S. in business communications from Bentley College, is a frequent contributor to ASA's SALT Blog; responds to public inquiries via the advice resource "Just Ask;" and is frequently quoted in traditional and social media on the topics of student loans and financial aid.