Since the mortgage crash nearly a decade ago, lending has become more complex. Through the qualified mortgage rule under the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act, lenders follow a rigorous process that takes a number of variables into account to determine whether a borrower will be able to repay the principal of the loan and not just the interest.
While an acceptable credit score and money saved for a down payment are important to get in the bank’s door, a borrower’s assets and liabilities are what the lender analyzes to determine whether the would-be homeowner can afford the loan being considered. Under the assets column, lenders primarily look at monthly income, but also consider a borrower’s savings, retirement funds, and other collateral. Under liabilities, a lender considers all obligations (or debts), including car payments, credit card debt, child support payments, and student loan debt. From these figures, a lender calculates a borrower’s debt-to-income ratio, dividing the total recurring monthly debt by the gross monthly income, to determine if there is enough room for payments on the home they want to buy.
The calculation of a borrower’s recurring monthly debt largely depends on the type of debt. “Revolving debt,” like credit cards for example, can have huge sums of debt attached to them. The only expectation is that a minimum payment be made, and depending on the card, this could be as little as $10 or $25 a month. Student loan debt, however, is a different story, and in 2016, when I was going through the process of buying a home, I learned that lenders did not look at the actual monthly payment I was making. Instead, they were allowed to choose between two options: 1) a theoretical monthly payment that would fully repay the loan over a specific period, or 2) 1 percent of the outstanding balance. These amounts were both higher than I was actually required to pay under federal income-based repayment plans on student loans, making my debt burden seem more severe than it was.
In April 2017, two federally-chartered companies that buy loans from banks, Fannie Mae and Freddie Mac, addressed this problem by allowing borrowers to use their actual reported payment amounts, so long as those payments are larger than $0, to demonstrate their student loan burden. Many Americans with modest incomes, however, still face an unfair barrier because the Federal Housing Administration (FHA)—which often supports lower-income first-time home buyers—is still using outdated guidelines that fail to take student loan realities into consideration.
How We Got Here
Measuring monthly debt for student loans was not always complicated; in the past underwriters would simply look at the monthly payment reported to credit bureaus. However, as the number of repayment options grew to include income-based options, credit bureaus and loan servicers were slow to make the reporting adjustments. In addition, student loan servicers failed in their responsibility to help borrowers find the best repayment option, and more borrowers were being unnecessarily funneled into forbearance and deferment, reporting no payments to credit bureaus when they in fact had debts.
By the time deferment of these student loans ended, interest would capitalize and the newly minted homeowners had to worry about paying a larger amount of student loan debt and a mortgage they likely would not have qualified for. To address that problem, lenders started looking at debt amounts rather than payments to better analyze the student debt burden the borrower faced. But those reforms solved one problem while creating another: borrowers with lower, income-based payments appeared more burdened with debt than they really were.
But those reforms solved one problem while creating another: borrowers with lower, income-based payments appeared more burdened with debt than they really were.
As FHA maintains regressive guidelines for borrowers in active repayment, it is important to note that the policies are based on the student loans of the past. For underwriters, student loans have long been considered “installment debt,” because the repayment options in the United States have historically been fixed, and to complete your obligation, you would eventually repay the principal and accumulated interest.
However, newer income-based plans and their forgiveness options flip this assumption on its head, because the expectation is not always going to be that a borrower can fully repay the loan and interest. This expectation is more notable when a borrower opts into Public Service Loan Forgiveness (PSLF), where the debt forgiveness option kicks in after 120 qualifying payments (ten years) instead of the 20–25 year forgiveness associated with income-based plans. But for someone who has chosen to work in public service and has accepted a lower paying job, the expected forgiveness is never factored into the debt-to-income ratio, further penalizing the interested homebuyer on an income-based plan.
Because FHA debt-to-income guidelines have yet to come to terms with the phenomenon that some borrowers will not fully repay on their student loan debt, this generation of home-seekers is likely to be disproportionately impacted. One of the biggest advantages of an FHA home loan is that it allows for higher debt-to-income ratios than its conventional loan counterpart. But FHA is hurting would-be borrowers that need the program most by inflating the debt-to-income ratio. Ultimately, these guidelines are antithetical to the mission of the FHA loan program.
As more borrowers choose income-based student loan repayment, FHA continues to disadvantage homebuyers. The FHA loan program was designed to provide affordable homebuying opportunities to lower-income families. Not only do FHA loans allow for higher debt-to-income ratios, they also:
- require lower down payments
- are more flexible for weaker credit scores
- include insurance on the full life of the loan
- and provide stronger consumer protections for the borrower
Without making the important policy change in its underwriting guidelines on income-based student loan repayment, the FHA program fails the underserved communities it is meant to support. Low-income borrowers should not be forced to choose between affordable student loan repayment and buying a home.