Do Mortgage Lenders Look at Student Loans?
Student loans and your mortgage: Understand how lenders assess your student debt and the steps to take for home loan approval.
Mortgage lenders examine student loans as a significant financial obligation that influences a borrower’s ability to manage additional debt, such as a mortgage. Lenders evaluate various aspects of a borrower’s financial profile to determine their capacity to repay a home loan, and student loans are a direct component of that evaluation.
How Student Loans Factor into Mortgage Applications
Student loans play a direct role in how mortgage lenders assess a borrower’s eligibility, primarily through the debt-to-income (DTI) ratio and credit score. The DTI ratio compares monthly debt payments to gross monthly income, indicating a borrower’s capacity to take on new financial commitments. Lenders use this ratio to ensure a borrower can comfortably afford both existing debts and a new mortgage payment.
The DTI ratio is calculated by dividing total monthly debt payments by gross monthly income. For example, if a borrower has $1,000 in monthly debt obligations and a gross monthly income of $4,000, their DTI ratio would be 25%. While an ideal DTI ratio is 36% or lower, many lenders may approve loans for ratios up to 43%. Some government-backed loans, like FHA loans, can allow for DTI ratios as high as 50%. Student loan payments are included in this calculation, affecting the “debt” portion of the ratio.
Beyond the DTI ratio, a borrower’s credit score is influenced by their student loan history. Payment history is the most significant factor in calculating credit scores, accounting for 35% of the score. Consistent, on-time student loan payments demonstrate financial responsibility and contribute positively to a credit score. Conversely, late or missed payments can lower a credit score and remain on a credit report for years. A strong credit score increases the likelihood of mortgage approval and can secure more favorable interest rates and loan terms.
Impact of Repayment Plans on Mortgage Eligibility
The type of student loan repayment plan affects how mortgage lenders calculate the monthly payment for DTI purposes. While a standard repayment plan uses the actual monthly payment reported on the credit report, income-driven repayment (IDR) plans and deferred or forbearance statuses are handled differently. This can lead to a discrepancy between a borrower’s actual payment and the amount lenders use for qualification.
For federal student loans on an IDR plan, lenders may use the actual monthly payment if it is reported and greater than $0. However, if the IDR payment is $0 or not clearly indicated, or if loans are in deferment or forbearance, lenders impute a hypothetical monthly payment. For instance, Fannie Mae guidelines may require lenders to use 1% of the outstanding loan balance, while Freddie Mac guidelines might use 0.5% of the balance. This imputed payment is used for DTI calculation, even if the borrower is not currently making payments.
Specific mortgage types have guidelines for student loan calculations. For FHA loans, if the student loan payment is $0 or the loan is in deferment or forbearance, lenders are required to use 0.5% of the outstanding loan balance as a monthly payment for DTI purposes. VA loans have considerations; if student loan payments are deferred for at least 12 months after the mortgage closing, they might be excluded from DTI. However, if payments are active or expected to resume within 12 months, VA lenders calculate an estimated payment. These varying calculations across loan programs emphasize the importance of understanding specific lender and loan type requirements.
Preparing for a Mortgage Application with Student Loans
Preparing for a mortgage application when carrying student loan debt involves several proactive financial steps to enhance eligibility. A foundational step is to review credit reports from all three major credit bureaus for accuracy. Checking these reports allows borrowers to identify and dispute any errors, which could otherwise negatively impact their credit score and mortgage prospects. Understanding one’s current credit score provides a clear picture of creditworthiness from a lender’s perspective.
Borrowers should have an understanding of their student loan balances, interest rates, and current repayment statuses. Knowing these details helps assess their overall financial picture and how it aligns with mortgage qualification standards. This includes understanding if their current repayment plan will lead to an imputed payment by a mortgage lender, even if their actual payment is low or $0.
Strategically paying down debt can improve a borrower’s DTI ratio, particularly by reducing monthly payment obligations. While paying down high-interest debt is generally advisable, focusing on loans with higher monthly payments can more directly impact the DTI. Saving for a larger down payment and accumulating cash reserves demonstrates financial stability and reduces the loan amount needed, making a borrower more attractive to lenders.
Finally, it is advisable to consult with a mortgage loan officer early in the process. A loan officer can provide personalized advice, clarify specific lender requirements, and help navigate the complexities of student loan impacts on mortgage eligibility. Avoiding new debt, such as car loans or significant credit card balances, in the months leading up to and during the mortgage application process is also crucial, as new obligations can negatively affect the DTI ratio and credit score.