Getting Your First Mortgage When You Have Student Loans Just Got Easier

A photo to accompany a story about how student loans affect mortgages Getty Images/Next Advisor

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If student loan debt has delayed your dreams of owning a home, a recent change could make it easier to qualify for an FHA home loan.

The Federal Housing Administration updated how it requires lenders to calculate student loan debt with FHA loans. The aim is to remove student debt as a barrier to entry for getting an FHA home loan — the FHA says more than 45% of first-time borrowers have student loan debt and the previous guidelines negatively impacted people of color in particular. 

The change has the potential to increase access to FHA-backed mortgages for underserved communities and those who have student debt — and some previously ineligible borrowers could now be eligible under the change. The people who benefit the most are highly indebted borrowers with lower incomes, says Catalina Kaiyoorawongs, co-founder of the student debt financial wellness platform LoanSense.

Here’s what this change means for you:

Getting an FHA Loan Just Got Easier

For loans not in active repayment (forbearance, deferment, income-based repayment plan), the guidelines previously required FHA mortgage lenders to calculate a borrower’s monthly student loan payment using 1% of the total loan balance. This amount was then factored into their debt-to-income (DTI) ratio, negatively impacting borrowing potential. 

For example, a borrower may have a total balance of $100,000 in student loans. But they may be on an approved income-based repayment plan (IBR), contributing only $150 a month. Under the old guideline, the FHA lender would have to factor in $1,000 per month, based on the underwriting rule of 1% of the balance. 

Now, anyone taking advantage of an income-based repayment plan can have the actual dollar amount they’re paying factored into their DTI, as long as the payment is above zero dollars a month. And, if your student loans are in forbearance, deferred, or your IBR’s monthly payment is zero, then 0.5% of your student debt will be factored into your DTI. 

Like most loan programs, FHA loans have a debt-to-income (DTI) limit. DTI is the main factor lenders use to determine how much they are willing to let you borrow, and student loans are part of that assessment. This includes your current monthly debt payments and your future mortgage payments. 

These changes must be implemented by Aug. 16, the FHA says, though lenders are also allowed to implement them immediately. 

How It Works

In most cases, the maximum DTI allowed on an FHA loan is 43% of your monthly income. To calculate your DTI, take your debt payments and divide that number by your gross monthly income (before taxes). 

Here is an example scenario of how a potential FHA borrower in an income-based repayment plan is affected under the old and new guidelines:

Old Way

Monthly debts (car and credit card payment)$450
IBR Monthly Student Loan Payment$150
Monthly Income$3,500
Total Student Loan Balance $100,000
Used to calculate monthly student debt$1,000/month (1% of loan)
Total Monthly Debts Used in DTI$1,450/month
DTI ($1,450/$3,500)41.42%

New Way

Monthly debts (car and credit card payment)$450
IBR Monthly Student Loan Payment$150
Monthly Income$3,500
Total Student Loan Balance $100,000
Used to calculate monthly student debt$150/month (actual payment)
Total Monthly Debts Used in DTI$600/month
DTI ($600/$3,500)17.14% 

In the example above, the decrease in the DTI ratio is significant and can make a big difference in qualifying potential. The change can also affect how much one can borrow too. Lowering one’s DTI also increases their homebuying purchasing power.  

Who Can Take Advantage of The New FHA Loan Eligibility Rules?

Potential Homebuyers

For buyers, this change can mean two things: 

  1. You could qualify when you couldn’t before
  2. You could be eligible for a larger mortgage

But, for those wanting to purchase a home, it’s a tough market right now now matter what type of loan you get. Low housing inventory and exceptionally low mortgage rates have created bidding wars and caused home prices to spike. While the change could make it easier for first-time homebuyers to get an FHA loan, it’s unlikely to be a major gamechanger.

“It’ll be interesting to see over the next three to six months how this change impacts the market,” says Matthew Garland, division manager with the Garland Mortgage Group and co-host of the Rants & Gems real estate podcast. “I think this will continue to drive a seller’s market and continue to raise home prices nationwide.” In other words, the challenge of finding an affordable home and getting your offer accepted will likely continue.  

This makes it especially important to have a homebuying budget and to stick to it. Banks are often willing to lend buyers far more than what makes sense for people’s monthly budgets. That’s why it’s important to focus on what you can afford and not just how much a lender is willing to give you. FHA loans have a maximum DTI of 43%, but if certain “compensating factors” are taken into account, such as your down payment or cash reserves, you may qualify with an even higher DTI. 

Pro Tip

The maximum DTI for an FHA loan is 43% or higher, but many experts suggest keeping your DTI to 36% or less since the 43% doesn’t account for other everyday expenses.

Another important note: Your DTI doesn’t account for all of your monthly expenses, such as taxes, groceries, gas, maintenance costs, and unexpected medical bills. This is why some experts recommend you follow the 28/36 rule. This rule says your mortgage payment should account for no more than 28% of your monthly pre-tax income, and all of your debt payments (including your mortgage) should add up to no more than 36% of your monthly gross income. 

Potential Refinancers

If your student loan debt was the only thing keeping you from being able to refinance into a new FHA loan, then it’s worth looking into how much you might be able to save now. “For folks who want to refinance, this is a home run,” Garland says. “If they’re in that income-based repayment plan, we can use that payment to help them qualify, and now they’re able to refi and get a lower rate.” 

Keep in mind that you’ll pay closing costs of 3% to 6% of the balance when you refinance. And FHA loans have an extra upfront mortgage insurance premium of 1.75% of the mortgage balance in addition to ongoing mortgage insurance payments.

Compare the refinance options you qualify for before deciding if an FHA refinance is the right option for you. You’ll also want to be sure that you’ll be in the house long enough for potential savings to outweigh the costs of refinancing.