By: Tim Lucas, VP of Content, Home.com
Help for FHA applicants with IBR loan payments
A new bill being discussed in Congress could make home buying easier for those with student loans.
The bill seeks to change how lenders calculate student loan payments for FHA loans.
If approved, this small change could flip many buyers’ applications from “denied” to “approved.” Here are the changes.
What is the ‘Making FHA Work for Borrowers with Student Debt Act of 2021’?
The U.S. House Committee on Financial Services has come out swinging in 2021.
It’s already discussing a $25,000 grant for first-time, first-generation home buyers.
The Making FHA Work for Borrowers with Student Debt Act of 2021 is another bill that seeks to make homebuying easier. It is targeted at loan applicants who are on income-based repayment plans and others making reduced payments on student loans.
According to Urban Institute, about 8 million people have income-driven repayment plans, representing about 30% of student loans.
That means it could become easier for about 1 in 3 FHA homebuyers who are paying education loans.
The method: a small but significant tweak to how lenders calculate the student loan payment.
How the bill would change the student loan payment calculation
Currently, FHA requires lenders to qualify borrowers using a “worst case” student loan payment.
According to the FHA handbook, lenders must use the greater of either:
One percent of the outstanding balance on the loan; or
the monthly payment reported on the credit report
The lender can use the actual payment only when it’s fully documented and the loan will be fully paid off by the end of the loan term at the current payment.
So those with deferred loans, income-based repayment (IBR) plans, Pay As You Earn (PAYE and REPAYE), Income-Contingent Repayment and Income-Sensitive Repayment plans are hit with a much higher payment than they actually have to pay.
The bill may change that.
If passed, FHA lenders could use the monthly payment that the applicant is “actually required to pay on a monthly basis,” according to the bill’s draft.
This change could mean the difference between buying a house and continuing to rent for many would-be buyers in 2021.
A telling example
The current “one percent rule” could be devastating for a home buyer’s approval status.
Typically, FHA lenders allow about 45% of an applicant’s gross income to go toward monthly debts and future housing payment. This is called their debt-to-income ratio.
In the below example, the applicant’s “real” student loan payment is $500. But, the lender discovers the applicant is on an income-based repayment plan. Her balance is $100,000. The lender must assume a $1,000-per-month payment (1% of $100,000) because the payment won’t pay off the loan in the stated term.
Under current rules, this applicant may be denied for high debt-to-income. Under proposed rules, she would likely receive an approval.
What about deferred student loans?
Unfortunately, deferred student loans will likely still be under old rules even if this bill passes.
The bill’s draft states it only applies to a loan that “is required to be repaid through payments made on a regular basis and is not in a deferral status.”
But this probably isn’t a bad thing. A buyer could be put in harm’s way if he is paying $0 toward student loans now, but will start making a payment of $1,000 a few months after buying the home.
Still, deferred student loan holders would likely benefit if they apply after their payment kicks in, if they are on a reduced payment plan.
Would this only affect FHA loans?
Yes, this bill, if passed, would only change rules for FHA loans. Fannie Mae, Freddie Mac, USDA, and VA loans would retain their various rules around student loan payment calculation.
When will the bill become law?
The bill is still in very preliminary stages.
Often, these proposals go through many revisions or die completely on their way through the House and Senate. So, as of this writing, it’s still on the horizon. But we will keep this post updated with developments.
Check your home buying eligibility
If you have student loans, you may qualify to buy a home even without this rule change.
At the very least, you will know where you stand and can make plans for the future.