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 Oklahoma City, the repayment plan you select after July 1 could influence your mortgage qualification amount.

Why This Matters

Lenders factor in your student loan payments when calculating your debt-to-income ratio, or DTI. This ratio is essential in determining how much home you can afford. Therefore, your choice regarding student loans is also a significant part of your homebuying journey.

At NEO Home Loans powered by Better, we emphasize that the mortgage process should begin with education, not pressure. Here’s what you need to understand before you make a decision.

What’s Changing on July 1?

Starting July 1, there will be changes to federal student loan repayment options.

The most significant change is the discontinuation of the SAVE plan. Borrowers currently on SAVE will need to select a new repayment plan, or they may be automatically transitioned into another option.

Two plans are expected to be more prominent moving forward:

The Repayment Assistance Plan (RAP) bases your payment on income, potentially leading to a lower monthly payment for some borrowers.

The Tiered Standard Plan involves fixed payments derived from your original loan balance. While it may offer simplicity, it could also result in higher monthly payments.

Some borrowers already enrolled in Income-Based Repayment (IBR) might be able to continue on that plan for a limited time.

Why This Matters if You Want to Buy a Home

When applying for a mortgage, lenders review your monthly income against your outgoing expenses. This includes credit cards, car payments, personal loans, student loans, and your prospective mortgage payment. Together, these elements form your DTI.

If your student loan payment increases, your DTI rises, which may reduce your buying power. Conversely, if your student loan payment decreases and is properly documented, your buying power may improve. This highlights the importance of selecting the right repayment plan.

The Part Many Borrowers Overlook

Even if your current student loan payment is $0, a mortgage lender may not view it that way. In some instances, lenders estimate payments, often calculating 0.5% of your total student loan balance.

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

RAP, IBR, or Standard: Which Plan Is Best for Buying a Home?

There is no universal answer. The optimal plan is contingent on your income, loan balance, family size, timeline, and the type of mortgage you are seeking.

Generally, RAP may be beneficial if it offers a lower documented monthly payment than what the lender would otherwise use. IBR could be advantageous if you are already enrolled and your payment is low or $0, particularly if applying for a conventional loan. Standard repayment might be suitable if you prefer a fixed, easy-to-document payment and your income can support it.

The key term here is documented. A low payment is only beneficial to your mortgage application if your lender can verify it.

FHA and Conventional Loans: Different Treatment of Student Loans

This aspect is crucial. Conventional loans may provide more flexibility when utilizing an income-driven repayment amount, especially if documented accurately. In contrast, FHA loans often have stricter guidelines. Many FHA lenders will use either your documented payment or 0.5% of your student loan balance, whichever is higher.

This discrepancy means two buyers with the same income and student loan balance could qualify differently based on the loan program. Therefore, discussing your options with a mortgage advisor before selecting a repayment plan or applying for a mortgage is highly 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 to confirm your plan, balance, and required monthly payment. Pay close attention to any notices from your servicer if you are on SAVE.

Next, run the 0.5% test by multiplying your total student loan balance by 0.5%. This will provide a rough estimate of what a lender might consider if your payment is deferred or not properly documented.

After that, 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 during mortgage qualification.

Lastly, consult a mortgage advisor before making significant changes. Altering repayment plans, refinancing student loans, or applying for a mortgage can impact one another. A mortgage advisor can help model the numbers with you.

A Quick Example

Suppose you owe $60,000 in federal student loans. A lender applying the 0.5% calculation might count $300 per month in student loan debt. If your new repayment plan establishes a documented payment of $150 per month, that lower payment could positively affect your DTI. However, if your documented payment is $500 per month, your buying power may be less than you anticipated.

This illustrates that the best plan is not always the one that sounds most appealing but rather the one that fits best within your overall financial situation.

Frequently Asked Questions

Can I buy a home if I have student loans? Yes. Having student loans does not prevent you from purchasing a home. Lenders need to understand how your payments fit into your overall financial picture.

Will a $0 student loan payment help me qualify? It depends. Some loan programs may accept a documented $0 payment, while others might still account for 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. Changing your plan could influence your documentation, credit report, and qualifying payment.

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

Should I refinance my student loans before buying a home? Exercise caution. Refinancing could reduce your payment and improve your DTI, but converting federal loans to private loans may eliminate federal protections. Assess the full implications before proceeding.

The Bottom Line

Your student loan repayment plan can impact your mortgage approval, DTI, and buying power. However, with careful planning, it does not have to derail your homeownership goals.

Before July 1, take a few moments to review your student loan options and speak with a mortgage advisor who can help clarify the numbers.

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

Ready to find out where you stand? Start your online pre-approval with NEO Home Loans powered by Better and gain insight into your homebuying power within minutes, with no impact on your credit score.

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