So your borrower has deferred student loans. Let’s say $100,000 worth of them.
The deal may not be dead if you’re willing to do the work. First of all, you need to understand that the monthly payment amount noted on the credit report for loans in deferment is sometimes not valid. It often will be “$0” since the student loan servicer has yet to report a monthly payment amount to the credit bureaus.
Let’s face it: $0 is not accurate, especially with an unpaid principal balance of $100,000. At the same time, $2,000 is not accurate, either.
The $2,000 amount is the figure that will be used as the monthly student debt payment obligation by the conventional secondary mortgage market in the event an actual monthly payment amount cannot be documented through the student loan servicer. It is called “The 2% Exception.” Basically, the exception requires the underwriter to assume a monthly student debt payment equal to 2% of the unpaid principal balance unless otherwise documented. However, if you do the work to document what the borrower’s monthly payment amount would be when the loan comes out of deferment, your odds of qualifying the borrower dramatically increase.
For instance, a single individual with $100,000 in federal direct subsidized student loans (e.g.: Stafford and Perkins loans) who earns $65,000 annually would be able to evidence a monthly payment of $1,150 once the loan comes out of deferment, according to the Repayment Estimator at www.studentaid.gov. This assumes a standard repayment plan. Much has been made about income-based repayment (IBR) options but those options cannot be considered for loans in deferment since student loans automatically enter a standard repayment plan upon coming out of deferment.
To be sure, the scenario of $100,000 in student debt cited above is a bit extreme. Indeed, 87% of Millennials (age 18-34) owe less than $25,000, and 60% have no student debt whatsoever, Goldman Sachs Global Investment Research reports. According to an Experian study released in September, Millennials who have at least one student loan have a cumulative average outstanding balance of $27,305 in student loans and earn an Adjusted Gross Income (AGI) of $41,000.
Using these averages as inputs into the Repayment Estimator – and assuming a standard repayment plan and an interest rate of 6.8% – we arrive at a monthly payment of $314, which is 43% lower than the $546 payment that would be assumed using the 2% Exception. This scenario is more likely than the borrower with $100,000 in debt (which admittedly we used for shock value to get you to keep reading.) The point is, a loan officer who works with a borrower to document the monthly payment that will apply when their student debt comes out of deferment will stand a much better chance of successfully placing that borrower into a lower-cost conventional mortgage loan they will be able to afford over the long term.
Let’s do the math. The borrower earning $41,000 annually who has $27,305 in student debt should be able to document that they will be subject to a monthly obligation of $314 once their loans come out of deferment. Assuming a 43% back-end debt-to-income (DTI) ratio, and provided they have no other monthly debt obligations (such as a car loan), this borrower should be able to afford a monthly mortgage payment of approximately $1,150. In today’s market, that buys you a starter home and an opportunity to grow wealth through paid-in equity and home price growth.
When you cut through all the public narrative and hyperbole over the student debt issue throttling first-time home buyers and boil it down to the facts, it is clear that many young households will have the financial capacity to manage both student and housing debt. And with their investment in education likely to lead the way to solid annual income growth, the mortgage payment they can afford now should become more comfortable as the years pass.
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