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Jerrilyn Cordett-Sinclair, 41, and her husband, Aubrey Sinclair, 42, wanted to buy a home for themselves or Aubrey’s mother to occupy. But while the Los Angeles-area couple was house-shopping, Cordett-Sinclair says, a change in the Federal Housing Administration’s loan guidelines derailed their plans.
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The FHA used to allow lenders to exclude student loan debt from a borrower’s debt-to-income ratio if the payments were deferred. Debt-to-income ratio, often called DTI, is a calculation that helps lenders decide whether to approve a loan.
Percentage of monthly income that is spent on debt payments, including mortgages, student loans, auto loans, minimum credit card payments and child support.
Debt payments / income
Example: Jessie and Pat together earn $10,000 a month. Their total debt payments are $3,800 a month. Their debt to income ratio is 38% ($3,800 divided by $10,000).
When calculating debt-to-income ratio, the new rules require lenders to include either the borrower’s actual projected student loan payment or 2% of the deferred student loan debt.
For the Sinclairs, who have a 3-year-old daughter, the change meant the difference between buying a home and not.
“We were qualified for $500,000, but when they added the student loans in, we qualified for $100,000,” Cordett-Sinclair says. “We had a case number so that we could still buy before a certain date, but it didn’t work out.” The couple declined to provide details about the amount of their student loan debt.
‘Debt is debt’
The FHA Single Family Housing Policy Handbook gives lenders minimum guidelines to approve FHA-guaranteed home loans.
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The relevant paragraphs state that lenders must “use the actual monthly payment to be paid on a deferred liability, whenever available,” and that if the actual payment is zero or unavailable for a student loan, the lender must “utilize 2% of the outstanding balance to establish the monthly payment.”
“If people were in their deferral period, we didn’t treat that as debt. Now we do because debt is debt, deferred or otherwise,” says Brian Sullivan, a spokesman for the U.S. Department of Housing and Urban Development, the FHA’s parent agency.
Student loans backed by the federal government typically are deferred as long as the student is in school and for 6 months after that, says Heather Jarvis, an attorney and student loan consultant in Wilmington, North Carolina.
Private-market student loans are less likely to have a deferral mechanism, particularly when the parents rather than the student take out the loan, Jarvis adds.
For most borrowers, the actual projected payment is likely to be lower than 2% of the balance.
That’s true in part because, as Jarvis points out, student loan borrowers can choose from a number of repayment options, some of which are income-based.
“It really is true that with student loans your payment could be a wide variety of numbers depending on what (option) you choose. Estimating it is not going to be super-accurate,” she says.
Greg Cook, a mortgage consultant at Platinum Mortgage in Temecula, California, cites an example of a borrower whose student loans totaled approximately $20,000. The loans were not in deferral and the payment was about $123 each month.
“If we had to use 2% of $20,000, it would be $400,” Cook says. “The 2% is kind of an arbitrary number.”
Lenders can’t loosen the FHA requirement, but they can tighten it, putting on what are known as “overlays” that raise the minimum standard to qualify.
“They might say, ‘We’re going to use 2%,'” Cook says. “Or they might say, ‘We aren’t comfortable with 2%, so as an overlay, we’re going to use 3 or 5 or whatever that number happens to be.”
Variations in overlays are a reason borrowers might need to shop around for a mortgage to qualify.
How to find out
Mortgage borrowers who have student loans with deferred payments are well-advised to find out their projected monthly payments after their deferral periods.
Projected payments aren’t always easy to figure out. Many people have multiple student loans, some or all of which might have been consolidated, and servicers have been “notoriously incompetent,” to use Jarvis’ characterization.
“There’s a lot of misinformation and people have had a hard time navigating the system. The servicers can and do produce letters that say what the monthly obligations are on the loan,” she says.
Some borrowers can log in to their servicer’s online portal and print a letter that describes the status and projected payment of their loans.
“Before you even start the (mortgage) process, go to your student loan servicer and find out what that payment is going to be,” Cook advises. “You don’t want to get into escrow, and then have it become an issue.”
With buying a house off the table, Cordett-Sinclair and her husband pay $2,200 monthly rent for a 2-bedroom, 1-bathroom apartment in an older building in Beverly Hills, California.
She’s a teacher at a nonprofit educational unit of a major health care system. Her student loan payments are deferred because she’s working toward a doctorate in education. He’s a service specialist at a hygienic environment company.
“It was such a bummer,” Cordett-Sinclair says, “because I was so close to buying a home. We were looking every weekend. Then all of a sudden this information came and it totally stopped the whole process.”
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