In this article, we will discuss and cover mortgage agency guidelines on defaulted student loans. There are two types of student loans. Federal and private student loans. Federal student loans are student loans that have been guaranteed by the federal government. Federal student loans need to be paid.
Borrowers do not have to pay outstanding private student loans to qualify for a mortgage loan. However, all federal defaulted student loans need to be paid or in a workout payment plan for you to be eligible for a government-backed mortgage loan.
You cannot qualify for government-backed mortgage loans with delinquent student loans. HUD, the parent of FHA, has updated the cure of defaulted student loans for borrowers on FHA loans. You can now expedite working out your federal student loan default in less than one month and qualify for an FHA loan. In this article, we will cover qualifying for FHA loans with defaulted student loans.
You Cannot Qualify For A Mortgage With Defaulted Student Loans
If the student loan goes into collections, you cannot qualify for a government-backed mortgage loan if you have federal defaulted student loans. This includes government home mortgages like FHA loans. Private student loans are like any other installment loan. Government student loans are not exempt from bankruptcy discharge. However, private student loans are. If you have federal defaulted student loans, you need to get them out of the defaulted status before you are able to apply for a mortgage. In this article, we will discuss and cover the mortgage agency guidelines on defaulted student loans.
Mortgage Agency Guidelines On Federal Versus Private Student Loans In Default
Every year 1 million-plus Americans default on their student loans. Defaulted student loans massively affect consumers’ credit as well as home-purchasing abilities. A defaulted student loan means it has been moved to collections by the creditor. For federal defaulted student loans this will occur after 270 days without payment. For private defaulted student loans, the accounts go into collection status after 120 days after nonpayment. Michael McCue of Gustan Cho Associates said the following with regard to the negative impact of defaulted student loans:
A student loan going into default can cause a borrower’s credit score to drop 60+ points. A steep drop in consumer credit scores will affect their ability to qualify for various programs as well as the most competitive interest rate possible.
There is no way a borrower can qualify for a government-backed mortgage if they have delinquent federal student loans. The federal student loan needs to get out of arrears and into rehabilitation before they are able to qualify for a government home mortgage. However, borrowers can qualify for government and conventional loans if they have private defaulted student loans.
Fannie Mae And Freddie Mac Guidelines on Student Loans In Default on Conventional Loans
An applicant can still qualify for a conventional loan with a federal or private student loan in default with a high credit score and good timely payment credit history. Borrowers cannot have any other disqualifying factors besides delinquent federal and/or private student loans.
The borrower will need to be able to provide an explanation regarding what steps they have taken to make the loan current. The debt will be counted towards the borrower’s debt-to-income ratio.
FHA borrowers can proceed as well with a private student loan in collections under the same circumstances. However, borrowers with outstanding federal student loans in default will not be able to qualify for FHA loans.
How Defaulted Student Loans Impact Qualifying For Government-Backed Mortgages
Borrowers with defaulted federal student loans cannot qualify for government-backed loans. Borrowers with defaulted student loans cannot pass CAIVRS or the Credit Alert Interactive Voice Response System. CAIVRS automatically flags those with delinquent federal debt. Any FHA borrower with a defaulted loan on CAIVRS will be denied from qualifying for a government-backed mortgage until it’s brought out of default. There are 3 ways to get federal student loans out of default: rehabilitation, consolidation, or settlement.
Student Loan Rehabilitation
Loan rehabilitation used to take nine months. Prior to the new HUD update on defaulted student loans, the process of making nine consecutive was the typical student loan workout process. The workout rehabilitation of defaulted student loans used to take income-based payments to your student loan servicer. This makes up for the previous nine missed payments that led to default and bring the loan up to date.
After the nine payments are made your loan servicer will contact the credit bureaus to remove records of the loan being in default and you will regain the ability to forebear your loan, modify payment plans, and qualify for forgiveness.
Rehabilitation is the longest process to bring your loans out of default but it will likely lead to the largest boost in credit because it removes the record of the default from your credit report. However, the good news is HUD has expedited the rehabilitation of defaulted student loans to a thirty-day workout process.
Consolidating Your Student Loans That Are Defaulted
The next option is to consolidate your student loans with a direct consolidation loan. In order to qualify for consolidation, you must have at least one loan that hasn’t previously been consolidated.
You must agree to pay the future consolidated loan on an income-based repayment plan or make 3 full monthly payments prior to consolidation. This process will allow borrowers to qualify for forbearance, forgiveness, and eventual payment modifications.
The record of having defaulted will stay on their credit report which may continue to affect their credit score until it is removed in 7 years. The process of consolidation takes about 30-90 days making it at worst 3 times faster than loan rehabilitation.
Paying The Defaulted Student Loans In Full
The third option is to pay the defaulted loan in full or negotiate a settlement with your servicer. Settlements with student loan servicers are typically 80%-90% of the loan’s remaining balance and would be paid within 90 days of the approval from the servicer.
Private Defaulted Student Loans
When in default with a private student loan, borrowers will be able to pursue a mortgage unlike with defaulted government student loans. But the effect on the credit score and debt-to-income ratio will make it harder to qualify and increase the interest rate on their mortgage loan.
Private lenders do not have to offer the same programs to get your loans out of default, but borrowers still have similar options. The most effective options are to refinance or negotiate a settlement. By refinancing the borrower may get a lower monthly payment and will have closed the collection account which will eventually improve their credit.
Unlike a federal student loan consolidation, refinancing will not lead to the record of default being removed from credit, but a closed collection account will affect credit less over time. A settlement will relieve the borrower of the debt obligation and will eventually improve the borrower’s credit as well.- Private student loans that are defaulted can be charged off by the student loan provider. However, federal student loans cannot be charged off.
Mortgage Guidelines on Defaulted Student Loans
In the following paragraphs, we will discuss and cover student loans guidelines on purchase and refinance mortgages. Student Loans Guidelines On Purchase And Refinance Mortgages differ depending on the individual loan program. Student Loan Debt is one of the major hurdles and barriers for home buyers. This holds especially true for professionals with advanced degrees like doctors, dentists, lawyers, and educators. USDA Student Loans Guidelines are exactly those of FHA. VA loans have their own Student Loans Guidelines. Fannie Mae and/or Freddie Mac guidelines on student loans allow IBR Payments On Student Loans.
HUD Student Loans Guidelines On FHA Loans
HUD, the parent of FHA, now allows Income-Based Repayment plans, commonly referred to as IBR, on FHA loans. As mentioned earlier, USDA has the exact same student loan guidelines as FHA loans. So the student loan guidelines below on FHA loans apply to USDA Loans as well. Student loans guidelines on FHA loans have lightened up. You can now use 0.50% of the outstanding student loan balance as hypothetical monthly student loan debts on borrowers who have deferred student loans or do not know what the monthly fully amortized monthly loan payments are. HUD does not allow IBR Payments,
HUD does not exempt deferred student loans that are deferred longer than 12 months from being used for debt-to-income ratio calculations on FHA loans. You need to use 0.50% of the outstanding loan balance as a hypothetical debt when calcualting debt-to-income ratio on FHA loans. This holds true even though borrowers’ student loans are deferred for longer than 12 months.
Consumers with a permanently fixed student loan payment that has been fully amortized can be used as a monthly debt for DTI Calculations. Lenders need to have proper documentation to verify that monthly payments are fixed and amortized. Both interest rates and the repayment term of the outstanding student loan need to be fixed.
Deferred And NON-FIXED Student Loan Payments
HUD does not allow non-fixed student loan payments. Below are examples of non-fixed student loan payments:
- Deferred student loans
- Income-Based Repayment
- Graduated student loans
- Adjustable student loans
- Other types of repayment agreements that are not fixed
- All the above non-fixed student loan payments cannot be used on USDA and FHA loans
0.50 percent of the loan balance reflected on the credit report must be used as the hypothetical monthly payment. No additional documentation is required if the above 0.50% is used as the borrower’s hypothetical monthly payment. There are tricks of the trade we can discuss over the phone. We do have alternative hypothetical monthly payments other than the 1.0% rule. Please contact us at Gustan Cho Associates at 800-900-8569 or text us for a faster response. Or email us at gcho@gustancho.com.
VA Student Loans Guidelines
VA loans are the only loan program that permits deferred student loans that have been deferred longer than 12 months exempt from DTI Calculations. Per VA student loan guidelines, the mortgage can exclude deferred student loans that are deferred longer than 12 months from the DTI of borrowers. VA does not allow Income-Based Repayment Plans. Here is how non-deferred student loans are calculated on VA loans:
- Take 5% of the outstanding student loan balance that is reported on the consumer credit report.
- Divide by 12 months.
- The resulting figure will be the hypothetical monthly payment on VA loans
Getting Hypothetical Student Loan Payment From Student Loan Provider
If the payment amount reported on the consumer credit report is less than the threshold payment above, the borrower needs to do the following:
- Obtain a statement from the student loan provider
- The statement needs to state the loan terms and payment for each student loan
- The statement needs to be dated within 60 days of the closing of the VA loan
- Lenders may do a credit supplement on this
IBR Payments on Student Loans Are Allowed on Conventional Loans
Fannie Mae permits Income-Based Repayment on Conventional loans. It can also be a zero IBR Payment and Fannie Mae will allow it. If there is a monthly payment reflected on the consumer credit report, then that payment can be used as the actual monthly payment.
HUD, the parent of FHA, now allows Income-Based Repayment (IBR Payments) on FHA loans. Homebuyers with large outstanding student loans on income-based repayment can now qualify for FHA loans.
If the IBR payment is not reported on the consumer credit report, then the borrower needs to get an IBR statement from the student loan provider. The lender may do a credit supplement of the IBR Payment so it reflects on the borrower’s credit report.
Qualifying For A Mortgage With IBR Payments on Student Loans
If the consumer credit report doesn’t provide a monthly figure or reflects zero, the lender needs to confirm the IBR Payment as follows. If a mortgage borrower is on an IBR Plan, the borrower needs to provide a written statement from the student loan provider stating the borrower has a zero IBR Payment. Mortgage Underwriters can qualify borrowers with zero IBR Payments with Fannie Mae. Freddie Mac does not allow zero IBR Payments.
Hypothetical Versus Fully Amortized Monthly Payments Over Extended Term
0.50% of the outstanding student loan balance is used for deferred outstanding student loans OR the borrower can contact the student loan provider and get a fully amortized monthly payment on an extended term. This needs to be in writing. Gustan Cho Associates are experts in working and qualifying borrowers with high outstanding student loans and high debt-to-income ratios. Please contact us with any questions at 800-900-8569 or text us for a faster response. Or email us at gcho@gustancho.com. The team at Gustan Cho Associates is available 7 days a week, on evenings, weekends, and holidays.
March 12, 2023 - 8 min read