Buying a home is generally a good long-term investment. It can provide stable monthly payments, an opportunity to build equity, and you’ll have greater control over your living space. Yet, homeownership isn’t without hurdles.
Some people have trouble meeting down payment requirements, but this isn’t the only roadblock to homeownership. Student debt is another obstacle—and according to a 2017 report by the National Association of Realtors, “about 83% of non-homeowners say student debt prevents them from buying a home.”
The good news, though, is that change is on the horizon.
In an effort to boost ownership among would-be buyers with student debt, the Federal Housing Administration (FHA) — a unit of the Department of Housing and Urban Development (HUD)—is adjusting the way student debt impacts a borrower’s debt-to-income ratio. The aim is to not only make FHA loans more accessible, but also address inequities in homeownership.
CHANGES UNDER THE NEW RULE
FHA loans are government-backed loans that are popular with first-time homebuyers because of their lower down payment and credit score requirements. But despite FHA’s flexible underwriting standards, guidelines regarding student debt calculations have made it harder for some people to qualify for financing.
Along with reviewing an applicant’s income and credit, lenders also calculate their debt-to-income (DTI) ratio. This ratio refers to the percentage of a borrower’s gross monthly income that goes toward monthly debt payments.
To qualify for an FHA home loan, a borrower’s DTI typically can’t exceed 43%.
Under the old rule, student loan borrowers with an income-based repayment plan (and those with deferred loans) were at a disadvantage because the method used by FHA lenders to calculate DTI often inflated their percentages.
Known as the 1% rule, lenders assumed a borrower made monthly student loan payments equal to 1% of their unpaid balance. So if a borrower had $50,000 in unpaid student loan balances, lenders assumed a monthly payment of $500. Similarly, if a borrower had $100,000 in unpaid balances, lenders assumed a monthly payment of $1,000.
This method of calculation, however, pushed some DTI ratios too high, ultimately disqualifying certain borrowers.
Under the new rule, which lenders can implement immediately, FHA lenders will now use a borrower’s actual monthly student loan payment when calculating their debt-to-income ratio.
This one change will help more people qualify for a mortgage, which is a huge relief for first-time homebuyers and recent graduates who prefer FHA financing because of their lower minimum requirements.
This update also benefits Blacks, Hispanics, and other borrowers of color who tend to carry more student loan debt, and who often pay more in homeownership costs.
According to the National Center for Education Statistics, roughly 86.3% of Black students borrow federal student loans, compared to 67.7% of white students. Some reports also estimate that Blacks pay an additional $60,000 in lifetime homeownership costs.
This change should give more families a chance to build generational wealth, while promoting greater equity and opportunity for homeownership.
To qualify for a FHA loan, you’ll need to contact an FHA-approved lender like FirstBank Mortgage. FHA loans have minimum credit score and down payment requirements, and your lender can discuss those with you. For more information about FHA loans, contact the loan experts at First Bank Mortgage.