There’s been a great deal of press in recent years about the impact student loans have on the larger economy, especially home purchasing. A Federal Reserve Bank of New York report showed a decline of 8 percentage points in home ownership among 28-to-30-year-olds from 2007 to 2015, and estimated that about 1/3 of that can be attributed to student loan debt. Because that’s all a little abstract, and because decisions families make now about college and student loans have the potential to cast a long shadow on the student’s life, I asked mortgage broker Tim McBratney of Pacific Residential Mortgage to explain how student loans affect the mortgage qualification process. He notes that the process has gotten more difficult with respect to student loan debt.
Here’s what Tim says:
Just last year in 2018 both Fannie Mae and Freddie Mac stated that their portfolio of loans was as strong as they have ever been in their respective histories. Fannie Mae began in 1938.
Consequently they recognized that they both could loosen their rules a bit. Due to the mortgage meltdown of 2009 from the very loose rules and regulations during 2000 up to that point they got very conservative. The ability to qualify for a mortgage after 2009 went back to the old days of underwriting a loan and much more. Frankly, it was not easy to qualify for a mortgage.
Loan quality got cleaner.
Since last year we saw some loosening as far as counting rent from a departing residence as well as documentation on ‘reserves’—money left over after closing on a home purchase for emergencies.
Some income rules even loosened up.
But one exception to all this loosening pertained to student loans.
In fact, the rules got tighter.
I believe that both investors (FNMA/FHMC) recognize the high cost of college and the ease in obtaining student loans for college kids and came to fear to ensuing payment explosion.
The rules of the past allowed us to ‘defer’ the payments along with the deferment of student loan payment while at school.
We have seen kids come out of college and, especially, grad or professional school such as medical and law school, with as much as $½ million to $1 million in loans. Indeed these are the exceptions but it is not uncommon to see $60,000 to $100,000 in student loan debt just from undergrad college. I had a married couple who both went to medical school and each have over half million dollars in loans! Knowing these loan payments were coming due both Fannie and Freddie tightened up.
Other investors followed including FHA, VA and USDA and others.
Now, when a borrower applies for a mortgage we have to determine what their future payments will be even if their loans are deferred until graduation. Their credit report may show $0 or ‘deferred’ but we need to know what the payment will be.
We must consider the payment in their qualifying ratios. This is known as the DTI or debt to income ratio. While we do not want a borrower’s proposed housing expense or payment to exceed roughly 33% to 35% of their gross monthly income we also need to consider their other debt payments such as auto or installment loans, revolving credit and other obligations. These typically cannot exceed 43% to 50% of gross monthly income depending on the loan program. USDA is a very strict 42% as long as their housing does not exceed 29%.
With a potential exploding student loan payment burden Fannie Mae and Freddie both decided to get conservative. And wisely so.
Every program has a little different twist on how to count the payment on a loan that is deferred. A good rule of thumb is 1% of the loan balance. If you have, say, $60,000 in debt that is $600. Add a car loan payment of $350 and some revolving payments that is nearly $1000 of ‘other debt’ that we must consider in a borrower’s qualifications. We may have to lower their housing expense just to get them into a home.
Don’t get too discouraged as there are many tricks to qualifying for more home. That is where a seasoned loan professional can help.
Tim McBratney is a Sr. Mortgage Banker at Pacific Residential Mortgage.