Tucker Mortgage

How Student Loans Impact the Mortgage Process

Almost 70% of the nation’s student loan borrowers are between the ages of 25 and 49, which overlaps heavily with the largest group of first-time home buyers – many of whom are worried about how their student loan payments will affect their ability to get a mortgage.

Having student loan debt won’t automatically be a barrier to your homeownership dreams – but they do factor into the process lenders use when they are trying to decide if someone qualifies for credit.

The Pause in Payments Changed the Outlook for Borrowers

During the Covid-19 pandemic and after, federal student loan repayments were paused. From March 2020 through October 2023, a lot of people with student loans were able to benefit from the pause in required payments to improve their odds of obtaining home loans, including in the following ways:

  • The average student loan borrower was able to save about $210 a month on their loans, and many of them put that money to good use by either saving it toward down payments or otherwise using the money to improve their situation.
  • Borrowers took the chance to reduce their overall debt. Roughly 44% of the people who were able to save money during the federal pause on payment used that money to pay down their credit card debts, and another 6% reduced their debts on other loans, like those for vehicles.
  • All the extra payments helped people raise their credit scores. The people who saw the most improvement were those who had struggled before with delinquencies or marginal credit. A better credit score makes it easier to obtain a mortgage.
  • Some borrowers inched closer to forgiveness. Borrowers on income-driven payment plans for their student loans and public service workers both qualify for loan forgiveness or discharges after so many payments. All those months where they weren’t required to pay actually count toward the total. That puts many people much closer to freedom from the yoke of student debt than they were before.
  • Other borrowers took a golden opportunity to cure their defaults or reduce their principal balances. The zero-percent interest imposed on student loans during the federal pause on payments gave the 18% of borrowers who kept paying a chance to reduce what they owe and save on interest in the future, while more than 600,000 borrowers got their loans out of default, which also improves their credit scores.

Now, the federal pause in the student loan payments is about to end, and borrowers aren’t going to see the widespread mass cancelations of those debts that they had hoped to receive. That means taking a fresh look at how student loans affect the mortgage application process.

What Can Those with Student Loans Expect from the Mortgage Process Today?

The number one way that student loan debt affects the mortgage process is when it comes time to calculate a would-be borrower’s debt-to-income (DTI) ratio. This is the amount of a borrower’s monthly expenditures compared to their monthly income. Student loan payments have to be included in this calculation. The more student loan debt a borrower has, the higher their DTI – and that can make it difficult to gain a lender’s trust.

However, figuring out exactly how student loans need to be factored into an underwriter’s calculations may depend a lot on the individual borrower’s situation. 

Freddie Mac, one of the prominent government-sponsored mortgage enterprises in the United States, has recently introduced new guidelines that will affect how lenders assess mortgage applications from borrowers with educational debt.

Effective September 6, 2023, Freddie Mac mandated that mortgage companies show that people with student loans owe at least a small amount (aka, a non-zero payment amount), even if they don’t have to make payments based on their income. This adjustment is a proactive response to the conclusion of pandemic-related forbearance for educational loans and is in line with guidelines from Fannie Mae and other government-backed mortgage lenders. 

Currently, it doesn’t matter whether someone with student loan payments is in deferral, has a forbearance or they’re making payments. All the major mortgage backers (Freddie Mac, Fannie Mae, the U.S. Department of Veterans Affairs (VA), the Federal Housing Administration (FHA) and even the U.S. Department of Agriculture (USDA) all impose similar standards. 

The only way that a student loan won’t be counted toward a borrower’s DTI is when the debt has been fully forgiven. If the borrower is making monthly payments, the actual loan payment (as shown either on the borrower’s credit report or their student loan statement) will be used. Borrowers who still have their payments deferred or in forbearance will have at least .5% of their balance or more listed on their application.

Does this spell an end to the homeownership hopes of student-loan borrowers? Not at all. However, the end of the federal repayment pause does mean that some potential buyers may need to delay their plans to prioritize paying down other debts or continue saving for a down payment. Consistent, timely student loan payments can also positively impact an individual borrower’s credit score. Others may want to look into forgiveness programs through federal, state and nonprofit organizations.

If you’re saddled with student loan debts, what does all this mean for you? It’s essential to manage your student loans responsibly, make on-time payments, and consider their impact on your financial situation before applying for a mortgage. Additionally, working to improve your credit score and reduce your debt-to-income ratio can help you qualify for a mortgage with more favorable terms.

Before applying for a mortgage, it’s a good idea to consult with a mortgage lender or financial advisor who can guide you on how your specific student loan situation may affect your mortgage eligibility and terms.