Buying a First Home With High Student Loan Debt: 2017 Update

First-time home buyers with a relatively high level of student loan debt sometimes have a harder time qualifying for mortgage loans. That’s because lenders view them as a potentially bigger risk, compared to a borrower with less overall debt.

Statistically speaking, a first-time buyer with high student loan debt is more likely to default on a mortgage loan. And lenders know this. So the higher your debt level, the more likely you are to be turned down for a loan. That’s the reality of the mortgage industry today, like it or not.

But a new rule announced in April 2017 could make it easier for first-time home buyers with high student loan debt to qualify for mortgage loans.

Specifically, borrowers who have debts that were paid by someone else in the past (such as a parent or other family member) could have their debt-to-income ratios revised downward during the mortgage application process. This in turn could improve the borrower’s chance for loan approval.

How High Student Loan Debt Affects Mortgage Borrowers

Student loan debt by itself is not necessarily a bad thing. It could actually boost a person’s credit score and increase the chance for mortgage approval, especially if the borrower (A) has made all loan payments on time and (B) has sufficient income to meet those obligations.

But relatively high student loan debt can negatively affect first-time home buyers and lower their chance for getting a mortgage loan.

It all has to do with something known as the debt-to-income ratio, or DTI. Banks and mortgage lenders analyze these ratios to get a feel for how much debt a person has, in relation to his or her income. In short, a higher DTI suggests a higher risk of default — and vice versa.

DTI evaluation helps lenders ensure that you aren’t taking on too much debt, with the addition of a mortgage loan. So it protects the borrower as well as the lender.

Generally speaking, mortgage lenders prefer that the borrower’s total debts use up no more than 43% of monthly income. Some set the bar a bit higher, and there are exceptions to this general “rule.” So that number is not set in stone. But it’s a good indicator of current lending standards.

As a result of these standards, first-time home buyers with high student loan debt (possibly on top of other obligations, like credit cards and auto loans) can encounter additional hurdles to mortgage approval.

And it makes sense, when you think about it. If a would-be home buyer has a mountain of debt already — relative to her income — it doesn’t make sense to pile a mortgage loan on top. It’s a recipe for financial hardship, and possible loan default.

But a new rule announced by the mortgage-buying giant Fannie Mae last month could make it easier for first-time buyers with student loan debt to qualify for mortgage financing.

Relaxed Criteria Could Help Home Buyers in 2017

Fannie Mae and Freddie Mac are the two government-sponsored enterprises (GSEs) that buy mortgage loans, securitize them, and then sell them off to investors in the secondary market. This gives mortgage lenders more liquidity, allowing them to make more loans. The end-goal of all this is to give more borrowers access to mortgage financing.

In April 2017, officials with Fannie Mae announced that the GSE would adjust its rules for mortgage loan applicants who carry debt from student loans, credit cards, auto loans, etc.

In short, they’ll allow lenders to omit obligations that were paid by a third party in the past, when calculating the borrower’s DTI ratio. This could make it easier for first-time home buyers with high student loan debt to qualify for mortgage financing in 2017 and beyond.

According to a Fannie Mae news release, this change “widens borrower eligibility to qualify for a home loan by excluding from the borrower’s debt-to-income ratio non-mortgage debt, such as credit cards, auto loans, and student loans, paid by someone else.”

The bottom line to all of this is that first-time home buyers should not assume they’re unqualified for financing due to their current debt situation. New rules and provisions for 2017 could help this group qualify for mortgage financing, even if they weren’t able to do so in the past. The only way to find out where you stand is to speak to a lender.