How mortgage lenders can help borrowers with student loans buy homes
Student debt has risen steadily in recent years, and totals $1.4 trillion in 2017. That's nearly three times what was owed in 2006, making student loan debt the largest non-housing debt class today.
Not surprisingly, paying hundreds of dollars a month toward student loan debt puts enormous financial pressure on graduates. This debt burden is one of the reasons that millennials are delaying life choices such as marriage, parenthood, and buying their first home.
In fact, millennials have one of the lowest homeownership rates for their age group of any in history. But it's not just millennials. Anyone with student loan debt could be affected.
While student debt may burden graduates for many years, obtaining a college degree still increases one's earning potential and the likelihood of owning a home, according to Fannie Mae's National Housing Survey. A bachelor's degree is still a good investment, even when financing that education requires student loans.
However, for those who started but did not complete their bachelor’s degree, the negative effect of student loans on homeownership is particularly acute. Additionally, having student loans may delay homeownership but does not seem to affect renters' long-term homeownership aspirations.
Given these facts, how can the mortgage industry ease the burden of student debt while also helping graduates safely achieve homeownership?
To address this challenge, one area of opportunity is home equity. There is $8.4 trillion in home equity in the U.S. That's a resource that homeowners can leverage to pay off student loan debt — either their own or debt they've co-signed. Fannie Mae introduced a Student Debt Cash-Out Refinance in 2016, which allows homeowners with 20% equity to refinance their mortgage and use the proceeds to pay down or pay off a student loan.
Now in 2017, building on what we've learned, some additional updates went into effect this year.
The first update involves underwriting the loan based on the graduate’s actual monthly student debt payments. Many students have entered into repayment plans based on their income that reduce their monthly student debt payments.
Historically, Fannie Mae required lenders to consider a fully amortizing payment for every student loan in the debt-to-income ratio calculation, regardless of whether the borrower was in an income-based repayment plan (which can significantly lower monthly payments). With the recent updates to policy, lenders can now use the lower income-based payments in calculating borrower debt. This policy change could have an immediate effect on people's ability to purchase a home since 10% of federally insured student loan debt holders are on an income-based repayment plan, and that percentage is likely to grow.
Some graduates are fortunate to have help with paying their bills, including their student loans. Often this help comes from a parent or even an employer.
In the past, debt for which the borrower was responsible but being paid by others would be included in the graduate's debts. Under the new policy, debt paid by others will not be calculated in the borrower's monthly debts as long as the borrower evidences the other party has been satisfactorily paying the debt for the past 12 months. This reduces the borrower's debt-to-income ratio, making it easier to qualify for a mortgage loan.
People who are already homeowners now have an opportunity to pay off high interest rate student debt while potentially refinancing to a lower mortgage interest rate. With this flexibility, Fannie Mae waives the fee that applies to most cash-out refinance loans.
Many recent graduates commonly believe that student debt automatically disqualifies them from getting a mortgage, and many view homeownership as merely a financial commitment, not a financial investment. Renters are often surprised to learn that the rent they currently pay can be as much as a monthly mortgage payment. What they may not know is that homeowners may get a tax break to offset costs.
Fortunately, education and outreach programs can help. Framework Homeownership offers an online course that includes information about calculating how much someone can afford, how to choose a real estate agent and shop for a mortgage, home inspection basics, and the closing process.
Another common roadblock young adults cite as a reason to delay home buying is having to save for a down payment. However, they often assume they'll need to save more than they actually have to. Many loans allow borrowers to put as little as 3% down. Or, for those who may qualify for a VA loan or are purchasing property in a designated rural area, there are zero-down options.
The housing industry needs to work together to help young adults achieve homeownership in a responsible way as 8.5 million households are burdened by student debt. Helping them is a huge opportunity for lenders.