Student Loans and Buying a Home: What the July 1 Deadline Could Mean for You
The short version
If you have federal student loans and are considering buying a home in Oxford, MS, the repayment plan you select after July 1 could influence the mortgage amount for which you qualify.
Why?
Lenders factor in your student loan payments when calculating your debt-to-income ratio, or DTI. This ratio is crucial in determining how much home you can afford. Therefore, your choice regarding student loans is also a significant decision for homebuying.
At NEO Home Loans powered by Better, we believe that the mortgage process should prioritize education over pressure. Here’s what you need to know before making a decision.
What’s changing on July 1?
Starting July 1, federal student loan repayment options will undergo changes. The most significant alteration is the discontinuation of the SAVE plan. Borrowers currently on SAVE will need to select a new repayment plan, or they may be automatically switched to another option.
Two plans are expected to gain prominence:
The Repayment Assistance Plan (RAP) bases your payment on income, potentially resulting in a lower monthly payment for some borrowers.
The Tiered Standard Plan uses fixed payments based on your original loan balance. While it may be easier to understand, it could also lead to a higher monthly payment.
Some borrowers already enrolled in Income-Based Repayment (IBR) may have the option to remain on that plan for a limited time.
Why this matters if you want to buy a home
When you apply for a mortgage, lenders assess both your monthly income and outgoing expenses. This includes items such as credit cards, car payments, personal loans, student loans, and your future mortgage payment. Together, these factors contribute to your DTI.
If your student loan payment increases, your DTI will also rise, potentially decreasing your purchasing power. Conversely, if your student loan payment decreases and is properly documented, your buying power may improve. This highlights the importance of selecting the right repayment plan.
The part many borrowers miss
Even if your current student loan payment is $0, a mortgage lender might not consider it as such. In many situations, lenders use an estimated payment, commonly calculated as 0.5% of your total student loan balance. For instance, if you have $60,000 in student loans, a lender may count $300 per month against you when determining your mortgage eligibility. This can significantly impact your situation.
Before assuming your student loans won’t affect your mortgage application, ensure you understand how your lender will account for them.
RAP, IBR, or Standard: Which plan is best for buying a home?
There is no universal answer. The optimal plan depends on various factors, including your income, loan balance, family size, timeline, and the specific mortgage type you are pursuing. In general, RAP may be beneficial if it offers a lower documented monthly payment than what the lender would otherwise use. IBR might help if you are already enrolled and have a low or $0 payment, especially when applying for a conventional loan. Standard repayment could be advantageous if you prefer a fixed, easy-to-document payment and your income can support it.
The key term here is documented. A low payment will only assist your mortgage application if your lender can verify and utilize it.
FHA and conventional loans may treat student loans differently
This distinction is important. Conventional loans often allow more flexibility with income-driven repayment amounts, provided they are documented correctly. On the other hand, FHA loans tend to be stricter. Typically, FHA lenders will use either your documented payment or 0.5% of your student loan balance, whichever is higher. As a result, two borrowers with identical income and student loan balances may qualify differently based on the loan program.
This is why discussing your options before selecting a repayment plan or applying for a mortgage can be beneficial.
What should you do before July 1?
Begin with these four steps:
First, check your current repayment plan by logging into your student loan account to confirm your plan, balance, and required monthly payment. If you are on SAVE, pay close attention to any communications from your servicer.
Next, run the 0.5% test by multiplying your total student loan balance by 0.5%. This will give you a rough estimate of what a lender may count if your payment is deferred or not properly documented.
Then, compare your payment options, considering RAP, IBR if available, and the Standard Plan. Avoid simply selecting the lowest online payment; consider how that payment may impact your mortgage qualification.
Finally, consult a mortgage advisor before making significant decisions. Changes to repayment plans, refinancing student loans, or applying for a mortgage all interact with each other. A mortgage advisor can help you model the numbers accurately.
A quick example
Consider a scenario where you owe $60,000 in federal student loans. A lender using the 0.5% calculation might count $300 per month in student loan debt. If your new repayment plan results in a documented payment of $150 per month, that lower payment could improve your DTI. However, if your documented payment is $500 per month, your buying power may be less than expected. This illustrates that the right plan is not necessarily the one that sounds most appealing; it is the one that best fits your overall financial picture.
Frequently asked questions
Can I buy a home if I have student loans? Yes, student loans do not automatically prevent you from purchasing a home. Lenders need to understand how the payment fits into your complete financial picture.
Will a $0 student loan payment help me qualify? Maybe. Certain loan programs may accept a documented $0 payment, while others may still count a percentage of your balance. It is essential to verify how your lender will handle this.
Should I switch repayment plans before applying for a mortgage? Not without consulting a mortgage advisor first. Changing your plan can impact your documentation, credit report, and qualifying payment.
Is RAP better for mortgage approval? It depends. RAP may be advantageous if it lowers your documented monthly payment, but for higher-income borrowers, it could result in a higher payment than anticipated.
Should I refinance my student loans before buying a home? Exercise caution. While refinancing may reduce your payment and improve your DTI, moving federal loans to private ones can eliminate federal protections. Consider the full implications before proceeding.
The bottom line
Your student loan repayment plan can influence your mortgage approval, DTI, and purchasing power. However, with the right planning, it does not need to hinder your homeownership aspirations. Before July 1, take a moment to review your student loan options and consult with a mortgage advisor who can help you understand the numbers.
At NEO Home Loans powered by Better, our mission goes beyond helping you secure a loan. We aim to assist you in making informed financial decisions that support your long-term wealth.
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