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 buying a home in Lake Oswego, OR, the repayment plan you select after July 1 could influence your mortgage eligibility.
Why?
Lenders assess your student loan payments when calculating your debt-to-income ratio, or DTI. This figure is essential in determining how much home you can afford.
Therefore, this is not solely a decision about student loans; it also significantly impacts your homebuying plans.
At NEO Home Loans powered by Better, we believe in starting the mortgage process with education rather than pressure. Here is what you need to know before you make a decision.
What’s changing on July 1?
Beginning 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. Failure to do so may result in automatic enrollment in another plan.
Two options are expected to become more prominent:
The Repayment Assistance Plan, or RAP, bases your payment on income. For some borrowers, this could lead to a lower monthly payment.
The Tiered Standard Plan uses fixed payments derived from your original loan balance. While it may offer simplicity, it could also result in higher monthly payments.
Some borrowers currently enrolled in Income-Based Repayment, or IBR, may have the option to remain on that plan for a limited time.
Why this matters if you want to buy a home
When applying for a mortgage, lenders consider your monthly income and outgoing expenses.
This includes obligations such as credit cards, car payments, personal loans, student loans, and your future mortgage payment. This cumulative figure is your debt-to-income ratio.
If your student loan payment increases, your DTI will also rise. A higher DTI could reduce your buying power.
Conversely, if your student loan payment decreases and is documented appropriately, your buying power may improve.
This is why selecting the right repayment plan is crucial.
The part many borrowers miss
Even if your student loan payment is currently $0, a mortgage lender may not consider it as such.
In some instances, lenders might use an estimated payment instead. A common approach is to calculate 0.5% of your total student loan balance.
For example, if you owe $60,000 in student loans, a lender may factor in $300 per month when evaluating your mortgage eligibility.
This can significantly impact your financial options.
Before assuming your student loans will not influence your mortgage application, ensure you understand how your lender will assess them.
RAP, IBR, or Standard: Which plan is best for buying a home?
There is no universal answer to this question.
The ideal plan depends on various factors, including your income, loan balance, family size, timeline, and the type of mortgage you intend to apply for.
Generally, RAP may benefit you if it results in a lower documented monthly payment than what your lender would use otherwise.
IBR may be advantageous if you are already enrolled and your payment is low or $0, particularly for conventional loans.
The Standard repayment plan might suit you if you prefer a fixed, easily documented payment and your income is sufficient to support it.
The key term here is documented.
A low payment will only enhance your mortgage application if your lender can verify and utilize it.
FHA and conventional loans may treat student loans differently
This distinction is vital.
Conventional loans often provide more flexibility when using an income-driven repayment amount, especially if it is documented accurately.
FHA loans, on the other hand, may have stricter criteria. In many cases, FHA lenders will use either your documented payment or 0.5% of your student loan balance, whichever is higher.
This means two buyers with identical income and student loan balances could qualify differently based on the loan program.
This is why it is helpful to discuss your options before deciding on a repayment plan or applying for a mortgage.
What should you do before July 1?
Start with these four steps.
First, check your current repayment plan. Log into your student loan account to verify your current plan, balance, and required monthly payment.
If you are on SAVE, pay close attention to any communications from your servicer.
Next, run the 0.5% test by multiplying your total student loan balance by 0.5%. This will give you a rough estimate of what a lender may consider if your payment is deferred or not adequately documented.
Then, compare your payment options by reviewing RAP, IBR if available, and the Standard Plan. Avoid simply selecting the lowest payment you find online; consider how that payment will be viewed in terms of mortgage qualification.
Finally, consult with a mortgage advisor before making any significant decisions. Changing repayment plans, refinancing student loans, or applying for a mortgage can all impact one another.
A quick example
Suppose you owe $60,000 in federal student loans.
A lender using the 0.5% calculation may count $300 per month in student loan debt.
If your new repayment plan results in a documented payment of $150 per month, that lower payment could positively influence your DTI.
However, if your documented payment is $500 per month, your buying power may be less than anticipated.
This illustrates that the right plan is not always the one that appears most favorable; it must align with your overall financial situation.
Frequently asked questions
Can I buy a home if I have student loans? Yes. Student loans do not inherently prevent you from purchasing a home. Lenders need to understand how your payments fit into your overall financial profile.
Will a $0 student loan payment help me qualify? It depends. Some loan programs may accept a documented $0 payment, while others may still apply 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. A change in plan can affect your documentation, credit report, and qualifying payment.
Is RAP better for mortgage approval? It varies. RAP may be beneficial 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. While refinancing may reduce your payment and improve your DTI, moving from federal loans to private loans can forfeit federal protections. Evaluate the full implications before proceeding.
The bottom line
Your student loan repayment plan can significantly impact your mortgage approval, DTI, and buying power.
However, with careful planning, it does not need to hinder your homeownership aspirations.
Before July 1, take the time to assess your student loan options and consult with a mortgage advisor who can help clarify the numbers.
At NEO Home Loans powered by Better, our mission extends beyond simply securing a loan. We aim to empower you to make informed financial decisions that contribute to your long-term wealth.
Ready to assess your situation? Begin your online pre-approval with NEO Home Loans powered by Better and gain a clearer understanding of your homebuying potential in minutes, without affecting your credit score.
Discover how much you could borrow.
