New FHA student loan policy changes ease old FHA home loan rules that made getting an FHA mortgage difficult for borrowers with student loans.
Student Loans & Home Loans
First, a quick background on student loans and home loans. Each mortgage program has rules on how lenders must calculate monthly debt payments for a borrower’s student loans.
VA mortgages allow deferred student loans to be omitted. Conventional home loans permit using ultra low Income Based Repayment plan (“IBR”) payments. Ultimately, each loan’s student loan policy impacts borrower’s debt to income ratios and how much loan they qualify for.
FHA & Student Loans – Out With The Old
Historically, FHA rules were un-friendly to student loans. Prior to 2021’s FHA changes, FHA required lenders adhere to the following 2 main rules*. Doing so often resulted in higher debt to income ratios and limited loan approval limits for FHA borrowers.
Old FHA Student Loan Rules
- 1% Method: Student Loan monthly payment equaled 1% of outstanding student loan balance when reported payment is $0 or “deferred”
- Fully Amortized Rule: Student Loan must fully amortize using the payment reported by Servicer in order for lenders to use that payment in qualifying a borrower
The 1% Method factored larger monthly payments into FHA borrower’s debt to income ratios. For example, a $60,000 student loan equated to a $600/mo payment being used by the lender. The Fully Amortized Rule disallowed using smaller reported monthly student loan payments when they did not fully pay the loan off at the end of it’s term. Both rules often resulted in lenders using unrealistically high monthly payments for student loans to qualifying someone for an FHA home loan.
*Contact the HOUSE Team for more on when each rule applied
In With The New – FHA & Student Loans
Finally, FHA loosened it’s kung fu grip on borrowers with student loans in 2021. FHA’s new student loan monthly payment rules yield lower monthly payments mortgage lenders can use when qualifying FHA borrowers.
New FHA Student Loan Rules
- .5% Method: Monthly payment used by lenders can equal .5% of outstanding student loan balance when reported balance is $0 or “deferred” – replaces 1% method
- Payment Above $0 Rule: Any payment reporting above $0/month may be used by lenders – replaces Fully Amortized Method
The Net Effect
Halving the old 1% Method down to the new .5% Method makes FHA qualifying easier. Using the same $60,000 student loan example above, the new .5% Method means lenders may use just $300/mo for the borrower’s student loan versus $600/mo under the old 1% Method.
Similarly, replacing the Fully Amortized Rule with the Payment Above $0 Rule allows FHA borrowers to qualify for more. Consider the same $60,000 student loan but this time the servicer reports a payment of $100/mo on the borrower’s credit. FHA’s new policy means lenders may use the reporting $100/mo for the student loan instead of $600/mo required under the old rules.
The way lenders apply these rules depends upon different factors. In short, both changes help FHA borrower’s qualify more easily by freeing up room in their overall debt to income ratios.