Student Loan Relief Could Inch You Closer to Homeownership
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Editor’s note: The student debt relief program is no longer accepting applications, though the Biden administration is seeking a path to reopen them. Borrowers can subscribe for updates directly from the U.S. Department of Education, or read our coverage of the Texas ruling that blocked the program here.
The Biden administration has announced a new student loan forgiveness plan that applies to individuals making less than $125,000 annually and couples making less than $250,000 annually. These borrowers will see $10,000 of their loans forgiven, while borrowers who received Pell Grants will see $20,000 of loan forgiveness.
When a portion of your balance is forgiven (or your entire balance, for borrowers with less than $20,000 of Pell Grant debt), it could impact many areas of your financial life, including your ability to buy a home.
However, the strength of that impact depends on factors such as whether you received a degree and where you are in your homebuying journey. Forgiveness may be a game changer for some, while others may need to explore alternatives, like government-backed mortgages or income-based student loan repayment, to afford a house.
Here’s how the policy could affect you.
If you’re buying soon, your debt-to-income ratio could be lower
If you’re actively looking to buy a home and planning to apply for preapproval, erasing $10,000 of your student loans now could lower your debt-to-income ratio. This figure shows lenders how much of your income is already tied up in debt payments — and how difficult it might be for you to pay your mortgage.
To calculate your debt-to-income ratio, tally all your monthly debt payments, divide the amount by your monthly income and convert it into a percentage. The lower that number is, the more appealing you’ll be as an applicant.
“Mounting student debt risks putting many would-be home buyers — particularly buyers of color — very close to or over conventional debt-to-income ratios, disqualifying them from homeownership even before they’ve applied for a mortgage,” according to a 2021 Zillow report.
At the time of the report, Zillow estimated that $10,000 of forgiveness per borrower could put as many as 1 million would-be home buyers’ debt-to-income ratios under what’s ideal to qualify for a loan, potentially gaining them a lower interest rate and a better chance of acceptance. This number is 36% for conventional mortgages, 41% for VA and USDA loans and 50% for FHA loans.
If you’re on the cusp of qualifying, $10,000 could put you over the edge. But it won’t make a difference for most borrowers, according to Christopher Haigh, certified financial planner and co-founder of financial advisory firm Iconoclastic Capital.
“If you take $10,000 off of a borrower’s federal student loans and they’re on a standard repayment plan, they’re probably only saving around $100 a month,” Haigh says. “They may go from qualifying for a $1,900 a month mortgage to a $2,000 mortgage."
» MORE: Calculate your DTI
If you have loans but no degree, this might improve your credit
Still, the impact of this debt relief plan could be “really large” for borrowers who took on college debt but left before completing their degree, says Jung Choi, who is a research associate at the Urban Institute, an economic and social policy think-tank.
Borrowers in this position have the burden of debt without the earning benefits of a degree. Additionally, “there’s some data showing that Black young adults are also more likely to miss their student debt payments than white young adults,” says Choi, meaning they’re also more likely to be dinged with credit delinquencies.
But if your loan balance — and monthly payments — are reduced by forgiveness, it could be easier to stay current. And that could improve your credit, as well as your odds of qualifying for a mortgage.
If you own a home, you could say goodbye to PMI sooner
If you already own a home, the Biden administration’s relief plan could also help make your payments more affordable.
Buyers who put down less than 20% on a house are required to pay private mortgage insurance until they reach 20% equity in the home. Since a lower down payment constitutes a riskier investment for lenders, they’re obligated to protect their interest with insurance.
With the forgiveness plan in effect, you could apply the difference in your student loan payments toward your mortgage instead, inching your equity stake closer to 20%.
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Borrowers still have an uphill battle
Current market conditions play a big role in the effectiveness of the proposed student debt relief plan. “The problem with this market right now is that even if you have less debt to pay, it’s really difficult to find affordable housing for young home buyers,” Choi says.
With home prices seeing double-digit growth from previous years and mortgage rates rising, many buyers are facing challenges, with or without student debt.
“I think if we were in normal times — or even just last year, when the rate was historically low — this kind of approach would have had an even larger impact,” Choi says.
Relieving $10,000 of student loan debt could also have a slightly negative impact on some borrowers’ credit scores because it could affect their length of credit histories, Haigh says. Student loans are among the typical borrower’s first credit accounts, so while eliminating the balance can be positive in the long run, borrowers planning to buy a home in the near future might see their scores dip.
If $10,000 isn’t enough, here’s what to do
Borrowers with high student loan balances may see $10,000 of forgiveness as a drop in the bucket. But there are other programs that can ease the financial burden of homebuying.
For example, if you went to medical school, you may consider a physician loan, which has flexible lending terms for doctors. Additionally, programs like Homes for Heroes help professionals such as nurses and teachers afford houses through reduced fees and rebates.
You may also consider a no- or low-down payment mortgage. VA loans and USDA loans require no money down, while FHA loans require just 3.5%. If your debt has negatively impacted your credit score, you can also work with a lender that specializes in borrowers with low scores.
You can make yourself a more attractive borrower, even with a high student loan balance. “Look toward income-based payment plans,” Haigh says. “It may be more favorable if you have a lower payment commitment.”
Mortgage lenders are more concerned with your debt-to-income ratio than with your total debt. By lowering your monthly payments through an income-based payment plan or private refinancing, you can free up more income for a mortgage payment.
“If you’re married, make sure that you’re structuring things in the most advantageous way possible,” Haigh says. This could include filing in such a way that your spouse’s income isn’t factored into your income-based payment plan, or applying for a mortgage in one of your names if the other has more debt or a lower credit score.
The impact of the Biden administration’s plan will be different for every borrower. But no matter where you are on your path to homeownership, $10,000 of relief could nudge you closer — even if only a little.