Fannie mae unveils new program for student-loan-laden borrowers
In an unexpected move, the country’s biggest mortgage agency is making getting approved for a mortgage much, much easier.
Fannie Mae announced three new features that will help those burdened with student loans to qualify to buy a house, or pay off their student loans via a refinance.
The new program is called Student Loan Solutions, and represents a major shift by Fannie Mae.
This comes as welcome news to the millions of Americans holding $1.4 trillion in student loan debt.
Before the change, new graduates and even those firmly established in the workforce experienced difficulty qualifying. Student loan payments pushed their debt-to-income (DTI) ratios over acceptable levels.
Buying a home remained a dream.
But eased standards are effective immediately. Home buyers or refinancing homeowners paying student loans may apply now, and have a much better chance of hearing “yes” from their lender.
Why are student loans hindering home buyers?
The first thing a lender looks at when approving a loan is the credit report. The second: debt-to-income ratios, also known as DTI.
DTI is the comparison of all your monthly debt payments compared to your pre-tax income. For instance here’s an example of a home buyer with an income of $5,000 monthly.
- Credit cards: $200
- Auto loan: $300
- Student loans: $500
- Proposed house payment: $1,500
This home buyer would likely not qualify for a home. Debt payments of $2,500 per month eat up 50% of his gross income, and the maximum lenders typically accept is 43%.
This buyer would need to either A) Find a less expensive home; B) Pay off debt, or; C) Keep renting.
But, what if new rules were published stating that lenders could “look at” the student loan payments differently? What if the lender could disregard the payment altogether?
The buyer’s DTI would be 40%, making him eligible to buy a home.
Lenders to look at student loan payments differently
Two of the three big changes published are concerning how a lender “looks at” student loan payments. For many home buyers, student loan numbers on paper don’t match what’s happening in real life.
That’s what Fannie Mae is addressing with these changes.
Change #1: Student loan payment calculation
Fannie Mae has changed how lenders calculate student loan payments.
Lenders may use the student loan payment as it appears on the credit report for qualification. Period. That may seem like common sense, but it’s not how things have been done in the past.
Before the change, lenders had to use 1% of the outstanding balance or the fully amortizing repayment amount. But this isn’t what student loan holders were actually paying if they were on an income-driven repayment (IDR) plan such as PAYE and REPAYE.
These plans allow graduates to repay student loans based on income. Often, the monthly payment isn’t enough to pay the interest owed. Lenders would have to calculate the monthly cost to fully repay the loan over the loan’s term. Often, the fully amortized payment was sky-high compared to the IDR-required amount.
The higher payment would put the buyer outside DTI guidelines.
For instance, a borrower makes $4,000 per month and has:
- A fully amortized payment of $750
- An income-driven repayment of $250
The lower amount shaves twelve points off the buyer’s DTI. That will help tremendously when going to qualify for a home loan.
Change #2: Student debt paid by others
Just because a payment shows up on a mortgage applicant’s credit report does not mean he or she pays it.
Often, that obligation is taken care of by a parent or another party.
In these cases, Fannie Mae is disregarding the payment altogether. That applies not only to student loans, but payments for all debts.
The home buyer simply provides documentation that its debt has been paid by another party, on time, for the past 12 months. Then, the lender completely eliminates the payment from DTI calculations. This applies to:
- Student loans
- Credit cards
- Auto loans
- Most other installment and revolving debt
Disregarding a payment altogether will do wonders for a buyer’s DTI and therefore mortgage approval.
However, the buyer must be “hit” with any mortgage debt paid by others. Additionally, the rule does not apply at all if the paying party has an interest in the transaction, such as a Realtor or the seller.
Except in these rare cases, most debt paid by others can be disregarded by providing a very small amount of documentation.
Change #3: New student loan cash-out program: pay off education loans with a refi
Perhaps the biggest shift of all is Fannie Mae’s rework of cash-out rules regarding student loans.
Homeowners may now pay off student loans using equity from their homes at lower rates and easier qualification.
Typically, cash-out refinances come with higher rates. They are considered higher risk by lenders and Fannie Mae. So, according to Fannie Mae’s loan level price adjustment matrix, a lender must charge an extra 1%-2% of the loan amount in fees or more, just because the loan is deemed “cash-out”.
Those extra fees usually translate to higher rates.
Now, Fannie Mae does not consider the loan a cash-out transaction if loan proceeds completely pay off at least one student loan.
This loan classification has never been seen before — a kind of hybrid between no-cash-out and cash-out financing. Fannie Mae simply calls it the Student Loan Cash-Out Refinance.
But the name is misleading. Fannie Mae eliminates the extra costs of cash-out and issues these loans at no-cash-out rates. (No-cash-out is also called limited cash-out or rate-and-term). This could save the homeowner thousands — and even tens of thousands — over the life of the new mortgage.
For instance, look at this example of a Student Loan Cash-Out applicant with a 670 FICO score, obtaining a loan of $350,000.
- Former rules: 4.25% cash-out loan with a payment of $1,720 monthly
- New rules: 4.0% student loan cash-out with a payment of $1,670 monthly
That $50 per month adds up to thousands over the loan term.
Additional savings are realized when paying off high-interest student loan debt. In the above scenario, the homeowner may have been paying off a $500-per-month student loan and wrapping it into her new loan balance.
The marginally higher mortgage payment potentially eliminates a massive student loan obligation.
This is why Fannie Mae is adjusting its rules. It realizes that, while home values have increased more than 30% since 2012, homeowners are not gaining traction with paying off student loans. Plus, student loans often come with higher rates than are available for mortgages.
Homeowners benefit with a more affordable situation and easier homeownership.
Student loan cash-out eligibility
To qualify for the Student Loan Cash-Out, homeowners must meet three basic guidelines.
- At least one student loan must be paid off, with cash-out proceeds sent directly to the student loan provider.
- Only the borrower’s student loans may be paid off (not those of another party)
- Student loans must be paid off in full. No partial pay-downs allowed
Maximum loan to values (LTVs) match those of traditional cash-out loans. It would have been nice to see Fannie Mae loosen LTV guidelines for student loan cash-out. For now, you will need decent equity to use the program.
Current maximum LTVs are as follows:
- 1-unit home with a fixed-rate mortgage: 80% LTV
- 1-unit home with an adjustable-rate mortgage: 75% LTV
- 2-4 unit home with a fixed-rate mortgage: 75% LTV
- 2-4 unit home with an adjustable-rate mortgage: 65% LTV
Remember that you will need about 5-15% in additional equity than the maximums stated above. You will need to increase your loan balance enough to generate enough proceeds to pay off a student loan in full.
What are today’s student-loan-enhanced mortgage program rates?
Today’s rates are at historic lows. It’s the perfect time to buy a home or refinance, despite student loans that have hindered your progress in the past.
New student loan rules are in effect immediately. If you’ve been denied, or simply have not yet tried, it’s a great time to check your home buying or refinance eligibility.