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 are considering purchasing a home in Irving, TX, the repayment plan you select after July 1 could influence your mortgage eligibility.

Why?

Lenders factor in your student loan payments when calculating your debt-to-income ratio, or DTI. This ratio is crucial in determining how much home you can afford.

This decision regarding student loans is also a significant consideration for your homebuying journey.

At NEO Home Loans powered by Better, we believe the mortgage process should prioritize education over pressure. Here is what you need to understand before making a decision.

What’s changing on July 1?

Effective July 1, federal student loan repayment options will be updated.

The most notable change is the discontinuation of the SAVE plan. Borrowers currently on the SAVE plan will need to select a new repayment option. If they fail to do so, they may automatically transition to another plan.

Two options are expected to gain prominence:

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

The Tiered Standard Plan utilizes fixed payments based on your original loan balance. While this option may be simpler, it could lead to higher monthly payments.

Some borrowers enrolled in Income-Based Repayment (IBR) may retain that plan for a limited period.

Why this matters if you want to buy a home

When applying for a mortgage, lenders evaluate your monthly income against your outgoing expenses, which include credit cards, car payments, personal loans, student loans, and your prospective mortgage payment. This assessment forms your debt-to-income ratio.

If your student loan payment increases, your DTI rises, which may reduce your purchasing power. Conversely, if your student loan payment decreases and is properly documented, your buying power could improve.

This highlights the importance of selecting the appropriate repayment plan.

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 situations, lenders use an estimated payment, often calculated at 0.5% of your total student loan balance.

For instance, if you have $60,000 in student loans, a lender might count $300 per month against you when assessing your mortgage eligibility. This can significantly impact your situation.

Therefore, before assuming your student loans won’t affect your mortgage application, it is crucial to 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. The best plan will depend on your income, loan balance, family size, timeline, and the type of mortgage you seek.

Generally, RAP may be beneficial if it offers a lower documented monthly payment than what the lender would otherwise use.

IBR may be advantageous if you are already enrolled and your payment is low or $0, especially for a conventional loan.

Standard repayment could be suitable if you prefer a fixed, easily documented payment and your income can support it.

The key aspect is documentation. A low payment is only beneficial 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 provide more flexibility when considering an income-driven repayment amount, particularly if it is properly documented. FHA loans tend to be stricter; often, FHA lenders will use either your documented payment or 0.5% of your student loan balance, whichever is higher.

This means two buyers with identical income and student loan balances could qualify differently based on the loan program. Thus, discussing your options before deciding on a repayment plan or applying for a mortgage is beneficial.

What should you do before July 1?

Start with these four steps. First, check your current repayment plan by logging into your student loan account and confirming your current plan, balance, and required monthly payment. If you are on SAVE, pay close attention to any communications from your servicer.

Second, run the 0.5% test by multiplying your total student loan balance by 0.5%. This will give you a rough idea of what a lender may consider if your payment is deferred, missing, or not properly documented.

Third, compare your payment options, including RAP, IBR if available, and the Standard Plan. Avoid simply selecting the lowest payment online; consider how that payment will appear for mortgage qualification.

Lastly, consult a mortgage advisor before making any significant changes. Adjusting repayment plans, refinancing student loans, or applying for a mortgage can all interconnect.

A quick example

Let’s say you owe $60,000 in federal student loans. A lender applying the 0.5% calculation may consider $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 benefit your DTI. However, if your documented payment is $500 per month, your buying power may be less than anticipated.

This illustrates that the best plan is not always the one that seems most appealing; it is the one that aligns best with your overall financial situation.

Frequently asked questions

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

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

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

Is RAP better for mortgage approval? It depends. RAP may help if it lowers your documented monthly payment. However, for higher-income borrowers, RAP might lead to a higher payment than expected.

Should I refinance my student loans before buying a home? Exercise caution. While refinancing might lower your payment and improve your DTI, converting federal loans into private loans can forfeit federal protections. Evaluate the full tradeoff first.

The bottom line

Your student loan repayment plan can significantly influence your mortgage approval, DTI, and purchasing power.

With careful 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 clarify the numbers.

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

Ready to assess your position? Begin your online pre-approval with NEO Home Loans powered by Better and gain a clearer understanding of your homebuying potential in just minutes, with no impact on your credit score.

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