For many home buyers, FHA loans have provided an alternative option to conventional loans because they offer more flexible qualifications and requirements. However, for borrowers with student loans, FHA loans were almost impossible to qualify for. Previous FHA student loan guidelines increased the amount of a borrower’s monthly payments, making their debt-to-income ratio much higher than it actually was and way too high for home loan approval with FHA.
The good news is that those guidelines have changed, and qualifying for an FHA mortgage with student loans has become much more borrower friendly. Here we look closer at the FHA student loan guidelines and what they mean for home buyers.
Student loans do not have to be a barrier to home ownership. Learn how to qualify for an FHA mortgage, even with substantial student loans.
- FHA loans used to be tricky for folks with student loans, but new rules make them more borrower-friendly. Now, your actual monthly student loan payment, not the entire balance, affects loan approval.
- Two types of student loans matter here: federal (think U.S. Department of Education) and private (like from banks). The type you have can affect your FHA loan chances.
- Old rules meant your student loan balance made your debt-to-income (DTI) ratio look bigger than it was. The new rules use your actual monthly payment or 0.5% of your loan balance to calculate your DTI.
- Having federal student loans in default? Big no-no for FHA loans. Private student loans in default? It’s a hurdle, but won’t automatically disqualify you.
- You can boost your chances for FHA loan approval! Make timely payments on debts, up your credit score, save for a bigger down payment, and work on a steady job history. Bonus tip: reducing your DTI by refinancing or income-based repayment plans can help too!
Understanding student loans
Student loans are financial tools designed to help students and their families pay for continuing education. These loans are designed to cover educational costs, such as tuition, books, and room and board. There are two types of student loans, and which loan type you have can affect you when applying for an FHA mortgage. The two types of student loans include:
- Federal student loans: These loans are offered by the U.S. Department of Education and can include Perkins Loans, Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans (Grad PLUS and Parent PLUS). These loans offer more favorable terms and flexibility for repayment, with payment often being based on your income.
- Private student loans: Student loans offered by banks and credit unions are considered private student loans. These may come with a higher interest rate and stricter repayment terms. Students often turn to these loans when federal loans do not cover all educational expenses.
How FHA treats student loans
When applying for an FHA mortgage, the lender will look at your student loans the same as any other debt to determine your eligibility. A student loan will impact your debt-to-income (DTI) ratio similar to a car loan or any other form of credit, with some unique considerations.
Old FHA student loan guidelines
For years, student loans have made it difficult to qualify for an FHA loan due to the guidelines that lenders were required to follow. When a student loan showed up on a credit report, the lender did not take into account the actual payment amount but rather the entire remaining balance. They then reported the monthly payment as 1% of the total balance, even if borrowers were paying much less through income-based payments or loan repayment programs.
For example, this meant that borrowers owing $100,000 in student loans and having a repayment of $150 based on an income-based repayment plan were instead showing a monthly repayment of $1,000 on paper, giving them a DTI too high for FHA loan acceptance.
New FHA student loan guidelines
New FHA student loan guidelines were released on June 6th, 2021, and were much more favorable to borrowers looking to qualify for an FHA home loan. These new guidelines stated that if you are currently making payments on a student loan, a mortgage lender will use the monthly payment amount displayed on your credit report. If you pay less than this amount and can provide documentation, they will use the actual payment amount. If no amount is listed, they will estimate your payment at 0.5 percent. In our example above, if no amount was listed, the lender would use $500 as the monthly payment when determining your DTI instead of the previous $1,000.
For borrowers with deferred student loans
If your student loans are currently deferred or in forbearance, and you are not making regular monthly payments, an FHA lender will use the 0.5% amount of your loan balance when determining your DTI.
For borrowers with student loan collections
If you have federal student loans in default, you will not qualify for an FHA loan. Lenders use CAIVRS, or the Credit Alert Verification Reporting System, created by the U.S. Department of Housing and Urban Development. This system reports any delinquencies, defaults, federal liens, and foreclosures that relate to federal loan programs. If you are flagged on this reporting system as having student loans in default, you will not be approved for an FHA mortgage or any other type of government-backed mortgages, such as USDA or VA.
If, however, you have private student loans in default, these will not automatically make you ineligible but are instead evaluated by the lender when determining debt.
How to improve your FHA approval with a student loanIf you are applying for an FHA loan with student loans in place, there are some things you can do to help improve your chance of approval. These include:
- Maintain a good payment history on all debts, including student loans
- Work to raise your credit score
- Build your savings and consider having more available for a down payment
- Create a stable employment history
- Lower your DTI
Buying a home with a student loan
Thanks to the new FHA guidelines, qualifying for an FHA mortgage is much more attainable for borrowers. Working to reduce your student loan payments and improve additional areas of your financial status, such as credit scores, can further help you qualify for an FHA mortgage and get you into your new home with mortgage payments you can afford while still paying off your student debt.
Guiding you through the home-buying process
At Hero Home Programs, we understand that the home-buying process can be overwhelming, especially for first-time buyers. Our goal is to help everyone achieve home ownership and we are here to help walk you through the home-buying process. Contact us today to learn more about how we can help you get the keys to your new home.