How student loan forgiveness could help first-time home buyers

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Canceling student loans means financial changes for millions of Americans. For some, it could be the difference between buying a house and being left outside to look inside.

President Joe Biden’s plan to forgive up to $20,000 in student loan debt for eligible borrowers and reduce income-based repayment plans will likely make it easier for many to get a mortgage, according to experts.

“This will make homeownership accessible to more people because student loans have kept many people out of homeownership,” says Stacie Rihl, homebuyer educator and real estate matchmaker.

While this limited discount doesn’t give every borrower a clean slate, it can make a big improvement to a potential buyer’s debt-to-equity ratio, although it may cause some people’s credit ratings to drop temporarily.

Here’s how experts say forgiveness could make a difference when applying for a mortgage.

What is your debt ratio?

The debt-to-income ratio, or DTI, is a measure of how much of your income is spent paying off your debts each month. Lenders do not necessarily focus on the total amount of your debt, but on the amount of your monthly payment. It’s calculated by dividing your total monthly debt payments — student loans, credit cards, car loans, etc. – by your gross monthly income. DTI requirements vary by loan type and lender.

The way lenders calculate DTI has been complicated a bit by the pause in student loan payments since the start of the pandemic. If you default on your loans, lenders may consider 0.5% or 1% of your outstanding balance, Rihl explains. “Which can be a lot,” she says. “If you have $50,000 in student loans, that’s a big monthly payment for lenders to consider.”

How Forgiveness Will Affect Mortgage Applications

The headline of the president’s announcement in August was forgiveness – $10,000 for borrowers who earn less than $125,000 a year ($250,000 for couples) and $20,000 for borrowers who have borrowed money. money under the Pell Grant program for low-income students.

“The impact of the student loan forgiveness program is that for borrowers whose student loan debt was part of the outstanding debt they have, it will reduce the amount of their outstanding debt,” said said Rob Cook, vice president of marketing, digital, and analytics for Discover Home Loans.

Having less outstanding debt makes it more likely that a mortgage lender will expect you to be able to repay the loan they are about to offer you, and therefore more likely to approve or authorize you for a larger loan. . This could be particularly helpful for borrowers who are already “on the fringe in terms of loan eligibility,” Cook said. If your credit and income are in good shape, but your large student loan balance is holding you back, forgiveness could put you on the brink.

Right now, “someone could have a great job and have a down payment, but if their debt-to-income ratio is too high, numbers are numbers, they can’t be approved,” Rihl says.

Close the gap

Black buyers are denied a mortgage to buy a home in twice the rate of the general population across the country’s 50 largest metro areas, according to a report by LendingTree, which analyzed data from the Residential Mortgage Disclosure Act of 2020. A likely contributor is the legacy of discriminatory policies such as redlining – in which borrowers were denied home loans in predominantly black neighborhoods – and discrimination by lenders against black borrowers. If you are denied a mortgage, keep shopping around with different lenders and maybe consider other types of loans, like FHA or VA loans. If you think you have been discriminated against, report it to your attorney general’s office or the US Department of Housing and Urban Development.

Monthly student loan payments can also be reduced

The president also announced a plan to create a new income-focused repayment program that would allow borrowers to cap their monthly payments at 5% of their monthly discretionary income.

This could further improve terms for borrowers, Rihl says, by further lowering monthly payments and lowering your DTI, even if the forgiveness doesn’t make much of a difference to your total loan balance.

“If you only use 5%, depending on how much they earn, it can really reduce the amount of that debt payment,” Rihl says. “I think it will make home ownership a lot more accessible for a lot of people.”

Pro tip

Consider an income-based repayment plan that caps your monthly payment. This could significantly improve your debt-to-equity ratio and increase your chances of closing a mortgage deal.

Forgiveness Could Hurt Your Credit, But Don’t Worry Too Much

If your loan is completely forgiven, your credit score could plummet, experts say. For many, student loans are the oldest accounts on their credit report, and losing it from your report will hurt your credit history. It’s only one factor that goes into establishing your credit score, and it’s not the most important one. Any drop would be temporary and not worth not having to pay around $10,000.

The total discount could also affect your credit mix if it’s the only installment loan you have – as opposed to a line of credit like a credit card – because credit rating agencies also check to see if you have of different types of credit.

You will have to wait to see the benefits

These student loans have not yet been forgiven. You will need to follow certain steps to take advantage of it, including applying before the end of the year.

But even once you’re approved, it will likely take time for your financial records to reflect the change. This means that if you are considering buying a home, you may not see the benefits of forgiveness until next year.

“People may have to wait until they’re approved and then they have to work with their lender and the credit bureau,” Cook says. “It will take some time for the amount of debt to accurately reflect on their credit report.”

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