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Student loan forgiveness means financial changes for millions of Americans. For some, it could be the difference between buying a home and being left on the outside looking in.
President Joe Biden’s plan to forgive up to $20,000 in student loan debt for eligible borrowers and to shrink income-based repayment plans will likely make it easier for many to qualify for a mortgage, experts say.
“It’s going to make homeownership attainable for more people because student loans have held a lot of people back from homeownership,” says Stacie Rihl, a homebuying educator and real estate matchmaker.
While this limited forgiveness won’t give every borrower a clean slate, it can make a big improvement in a prospective homebuyer’s debt-to-income ratio, although it could cause a temporary credit score drop for some.
Here’s how experts say forgiveness could change things when you’re applying for a mortgage.
What Is Your Debt-to-Income Ratio?
Debt-to-income ratio, or DTI, is a measure of how much of your income goes toward paying down your debts every month. Lenders don’t necessarily focus on your total amount of debt, just how much your monthly payment is. It’s calculated by dividing your total monthly payments on debts – student loans, credit cards, car loans, etc. – by your gross monthly income. DTI requirements vary by loan type and lender.
How lenders calculate DTI has been complicated a bit by the student loan payment pause since the start of the pandemic. If you’re not paying on your loans, lenders can factor in either 0.5% or 1% of your outstanding balance, Rihl says. “Which can be a lot,” she says. “If you have $50,000 in student loans, that’s a big monthly payment that lenders have to consider.”
How Forgiveness Will Affect Mortgage Applications
The big headline of the president’s announcement in August was the forgiveness – $10,000 for borrowers who earn less than $125,000 per year ($250,000 for couples) and $20,000 for those borrowers who borrowed 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’s going to lower the amount of debt they have outstanding,” says Rob Cook, vice president for marketing, digital, and analytics for Discover Home Loans.
Having less outstanding debt makes it more likely that a mortgage lender will expect you can repay the loan they’re about to offer you, and therefore be more likely to approve you or authorize a bigger loan. That could be especially helpful for borrowers who are already “on the margin in terms of being eligible for a loan,” Cook says. If your credit and income are in good shape but that big student loan balance is holding you back, forgiveness could put you over the edge.
Right now, “someone could have a great job and have a down payment, but if their debt-to-income ratio is too high, the numbers are the numbers, they can’t get approved,” Rihl says.
Closing the Gap
Black homebuyers are denied a mortgage to purchase a home at twice the rate of the population at large across the country’s 50 largest metro areas, according to a report by LendingTree, which analyzed 2020 Home Mortgage Disclosure Act data. One likely contributor is the legacy of discriminatory policies like redlining – in which borrowers were denied home loans in mostly Black neighborhoods – and discrimination by lenders against Black borrowers. If you’re denied a mortgage, keep shopping around to different lenders and maybe consider other types of loans, like FHA or VA loans. If you feel you’ve been discriminated against, report it to your attorney general’s office or the U.S. Department of Housing and Urban Development.
Monthly Student Loan Payments May Also Be Reduced
The president also announced a plan to create a new income-driven repayment program that would allow borrowers to cap their monthly payments at 5% of their monthly discretionary income.
That could further improve conditions for borrowers, Rihl says, by making monthly payments even smaller and reducing your DTI, even if the forgiveness doesn’t make much of a dent in your total loan balance.
“If you’re only using 5%, depending on how much they make, that can really decrease what that debt payment is,” Rihl says. “I think it will make homeownership a lot more accessible for a lot of people.”
Pro Tip
Consider an income-based repayment plan that caps your monthly payment. That could significantly improve your debt-to-income ratio and boost your odds of landing a deal on a mortgage.
Forgiveness Could Ding Your Credit, But Don’t Worry Too Much
If your loan is totally forgiven, your credit score could drop, experts say. For many, student loans are the oldest accounts on their credit report, and losing that from your report will hurt your credit history. That’s just one factor that goes into setting your credit score, and it isn’t the most important. Any drop would be temporary, and well worth not having to pay $10,000 or so.
Total forgiveness 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 look to see if you have a variety of different types of credit.
You’ll Have to Wait to See the Benefit
These student loans haven’t been forgiven yet. There are steps you’ll have to follow to take advantage, including applying by the end of the year.
But even once you’re approved, it will likely take time for your financial records to reflect the change. That means if you’re looking at buying a house, you might not see the benefits of forgiveness until next year.
“People may have to wait until they get approved and then they have to work with their lender and the credit bureau,” Cook says. “It will take some time for the debt amount to be reflected accurately in their credit report.”
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