Student Loans and Buying a Home: What the July 1 Deadline Could Mean for You

The Short Version

If you have federal student loans and you are considering buying a home in Kettering, Ohio, the repayment plan you select after July 1 could impact your mortgage qualification.

Why?

Lenders factor in your student loan payments when calculating your debt-to-income ratio, or DTI. This figure helps determine how much home you can afford. Therefore, your decision regarding student loans also influences your homebuying prospects.

At NEO Home Loans powered by Better, we believe that the mortgage process should begin with education, not pressure. Here is what you need to know before making a decision.

What’s Changing on July 1?

Beginning July 1, there will be changes to federal student loan repayment options.

The most significant change is the discontinuation of the SAVE plan. Borrowers currently on SAVE will need to select a new repayment plan or may be automatically transitioned to another option.

Two repayment options are expected to be more prominent moving forward:

The Repayment Assistance Plan (RAP) bases your payment on your income, potentially resulting in a lower monthly payment for some borrowers.

The Tiered Standard Plan uses fixed payments based on your original loan balance. While it may be simpler, it could also lead to a higher monthly payment.

Some borrowers already enrolled in Income-Based Repayment (IBR) may have the option to remain on that plan for a limited period.

Why This Matters if You Want to Buy a Home

When applying for a mortgage, your lender assesses your monthly income against your outgoing expenses. This includes credit card payments, car loans, personal loans, student loans, and your future mortgage payment. This calculation determines your DTI.

If your student loan payment increases, your DTI rises. As your DTI climbs, your homebuying power may decrease. Conversely, if your student loan payment decreases and is well-documented, your buying power could improve.

This is why selecting the right repayment plan is crucial.

The Part Many Borrowers Miss

Even if your student loan payment is currently $0, a mortgage lender may not consider it as such. In some instances, lenders might use an estimated payment, commonly calculated as 0.5% of your total student loan balance.

For instance, if you owe $60,000 in student loans, a lender may estimate a monthly payment of $300 when assessing your mortgage eligibility. This can have a significant impact.

Before assuming that your student loans will not influence your mortgage application, make sure you understand how your lender will account for them.

RAP, IBR, or Standard: Which Plan is Best for Buying a Home?

There is no universal answer to this question. The best plan depends on various factors including your income, loan balance, family size, timeline, and the type of mortgage you are pursuing.

Generally, RAP may be beneficial if it results in a lower documented monthly payment than what the lender would otherwise consider. IBR can be advantageous if you are already enrolled and your payment is low or $0, particularly when applying for a conventional loan. Standard repayment may be suitable if you prefer a fixed, easily documented payment and have sufficient income to support it.

The key term here is documented. A low payment is only helpful for your mortgage application if your lender can verify and utilize it.

FHA and Conventional Loans May Treat Student Loans Differently

This distinction is important. Conventional loans may offer more flexibility in utilizing an income-driven repayment amount, especially if properly documented. In contrast, FHA loans tend to be stricter. Often, FHA lenders will consider either your documented payment or 0.5% of your student loan balance, whichever amount is higher.

This means that two buyers with identical income and student loan balances could qualify differently based on the loan program they choose. This is why it is beneficial to discuss your options before selecting a repayment plan or applying for a mortgage.

What Should You Do Before July 1?

Start with these four steps.

First, check your current repayment plan. Log into your student loan account and verify your current plan, balance, and required monthly payment. If you are on SAVE, pay close attention to any communications from your servicer.

Next, run the 0.5% test. Multiply your total student loan balance by 0.5% to get an estimate of what a lender may count if your payment is deferred or not properly documented.

Then, compare your payment options. Evaluate RAP, IBR if applicable, and the Standard Plan. Avoid selecting the lowest payment online without considering how that payment will affect your mortgage qualification.

Finally, consult a mortgage advisor before making any significant decisions. Changes to repayment plans, refinancing student loans, or applying for a mortgage all interconnect and can have substantial effects.

A Quick Example

Suppose you owe $60,000 in federal student loans. A lender applying the 0.5% calculation may count $300 per month in student loan debt. If your new repayment plan results in a documented payment of $150 per month, that lower payment could enhance your DTI. However, if your documented payment is $500 per month, your buying power may be lower than anticipated.

This illustrates that the right plan is not necessarily the one that seems best; it is the one that aligns with your entire financial landscape.

Frequently Asked Questions

Can I buy a home if I have student loans? Yes, student loans do not automatically prevent you from purchasing a home. Lenders need to understand how the payment fits into your overall financial situation.

Will a $0 student loan payment help me qualify? It may. Some loan programs might accept a documented $0 payment, while others could still count a percentage of your balance. Confirm how your lender will handle it.

Should I switch repayment plans before applying for a mortgage? Not without consulting a mortgage advisor first. A change in plans can influence your documentation, credit report, and qualifying payment.

Is RAP better for mortgage approval? It depends. RAP may be beneficial if it reduces your documented monthly payment. However, for higher-income borrowers, RAP could result in a higher payment than expected.

Should I refinance my student loans before buying a home? Exercise caution. While refinancing may reduce your payment and enhance your DTI, converting federal loans to private loans can eliminate federal protections. Consider the full implications before proceeding.

The Bottom Line

Your student loan repayment plan can significantly impact your mortgage approval, DTI, and overall buying power. However, with appropriate planning, it does not have to hinder your homeownership aspirations.

Before July 1, take a moment to review your student loan options and consult with a mortgage advisor who can help you understand the numbers.

At NEO Home Loans powered by Better, our aim is not just to assist you in securing a loan. We strive to empower you to make informed financial choices that contribute to your long-term wealth.

Are you ready to see where you stand? Start your online pre-approval with NEO Home Loans powered by Better and gain a clearer understanding of your homebuying power in minutes, without impacting your credit score.

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