The Effects of Your Student Loan Balance on Your FHA Loan Eligibility
If you want to buy a house, an FHA loan might be able to help you out. Credit requirements for FHA-insured loans are less stringent, and down payments and closing costs are lower.
However, you may face additional challenges when applying for an FHA loan if you owe money on a student loan. The FHA mortgage guidelines for student loans are summarised below.
The Federal Housing Administration insures FHA mortgages, which are home loans provided by approved lenders (FHA). This insurance reduces the risk for lenders, allowing them to lend to borrowers who might not otherwise qualify for a home loan due to their income or credit scores.
As a result, FHA loans can offer borrowers lower interest rates than conventional mortgages, as well as more flexible down payment and credit history requirements. For maximum financing with FHA loans, you'll need at least a 3.5 percent down payment and a credit score of 580 or higher.
Your debt-to-income (DTI) ratio, which compares monthly debt payments to monthly income, must be 43 percent or less to qualify for an FHA mortgage (including the potential mortgage payment).
That's where student loans come in: even if you're not currently making payments on them, your student loans will be factored into your DTI when applying for an FHA loan. Student loans, in fact, may be treated differently than other types of debt.
Note that private lenders may have their credit, income, DTI, and down-payment requirements when it comes to FHA loans. As a result, it's critical to shop around for mortgage lenders who will work with you and a low-cost loan that meets your requirements.
Student Loan Debt and the One Percent Rule
According to FHA rules, all student loans with outstanding balances must be included when calculating your DTI ratio.
The regular payment amount is used for borrowers who have a fixed monthly student loan payment based on amortization. (Most lenders are aware of this figure because it appears on your credit report.)
But it isn't always that easy. Students in deferment or forbearance (including the automatic forbearance offered beginning in 2020 due to the pandemic) are not required to make payments, while those on income-driven repayment (IDR) plans, for example, may have very low monthly payments. The DTI for these borrowers will include an amount greater than what they are currently paying.
The reason for this is something known as the 1% rule. It states that lenders cannot calculate DTI using a student loan payment that is less than 1% of the outstanding balance.
Lenders must use the greater of 1% of the outstanding student loan balance or the minimum payment listed on the credit report when calculating the minimum payment. If the payment is less than that, they may use it if it is an amortization-based payment (such as a 20-year loan) and they have documentation of the original student loan agreement.
Based on the payment plan or status, here's how this rule might be applied to a $35,000 balance (5 percent interest rate and $35,000 annual income):
Monthly Required Payment
1% Rule Amount
Payment as Calculated for an FHA Loan
Private student loan with a 20-year term
Income-based repayment (with $35,000 income)
Deferment or forbearance
Other Factors to Consider When Getting an FHA Student Loan
Student loans are part of your credit history, which lenders will review during the loan application process, in addition to calculating your DTI. Late payments, delinquencies, or a student loan default can make it difficult to qualify for an FHA loan because lenders prefer a history of on-time monthly payments.
Request a free credit report to check your account information for potential red flags
Let's say that paying off your student loans on a monthly basis prevents you from setting aside enough money for a down payment and other home-related expenses. In that case, an FHA loan can help because it requires a lower down payment and closing costs than a traditional mortgage (usually 2 percent to 4 percent of the purchase price, versus 3 percent to 6 percent for most conventional mortgages available).
Alternatives to the Federal Housing Administration for Those With Student Loan Debt
In order to qualify for an FHA loan, you must have a high student loan balance in relation to your income. Here are some additional options and steps to think about.
Calculate your DTI using the 1 percent rule mentioned earlier. If it's too high, you can raise your income, pay off student loans or other debt, or do both.
A conventional mortgage is also an option, especially if you have a good credit score. For example, Freddie Mac loans use 0.5 percent instead of 1 percent to calculate loan payments that have been suspended due to forbearance or deferment.
Purchasing a home is an exciting experience. Taking stock of your student loan debt and weighing your options can help you determine whether or not an FHA loan is the best option for you.