Navigating FHA Loans When You Have Student Debt

Having student loan debt can make getting approved for a mortgage more challenging. But there are options like FHA loans, that may work for you even if you’re still paying off student loans. In this article we’ll break down how FHA loans handle student debt, recent policy changes, and tips for qualifying when you have outstanding student loans.

What Are FHA Loans?

FHA loans are government-backed mortgages issued by approved lenders and insured by the Federal Housing Administration (FHA) Their key advantages are

• Low down payments – As low as 3.5%
• More flexible credit requirements
• Lower mortgage insurance rates

These features make FHA loans popular, especially for first-time homebuyers and buyers with moderate incomes or high debt Over 1 million FHA mortgages are issued each year

How Student Loans Affect Mortgage Eligibility

When you apply for a mortgage, lenders look at your debt-to-income ratio (DTI). This compares your monthly debt payments to your gross monthly income.

Most conventional mortgages want your DTI to be below 43%. FHA loans allow for slightly higher DTIs, but debt still impacts your eligibility.

The more student loan debt you have, the higher your DTI will be. And if your DTI is too high, you may have trouble qualifying for an FHA loan or other mortgage products.

Previously, FHA policy made this especially difficult for some student loan borrowers. But recent changes have improved the situation.

Recent FHA Policy Changes for Student Loan Debt

In the past, FHA loans calculated your monthly student loan payment differently than other debt:

• For most debts, your actual monthly payment was used.

• But for student loans, they used either the monthly payment on your credit report OR 1% of your total student loan balance.

This often overestimated your real student loan payment, hurting your DTI and chances of approval.

However, FHA recently announced that they will now respect your actual student loan payment if you provide documentation of it. The only exception is if your payment is temporarily $0 due to forbearance or deferment – in that case, they’ll use 0.5% of your total balance.

This change, which went into full effect in August 2021, makes it easier to qualify for FHA loans when you have student debt.

Tips for Getting Approved for an FHA Loan With Student Loans

If you have outstanding student loans and want to get an FHA mortgage, here are some tips that can help your chances:

• Provide documentation of your actual monthly payment – This allows the lender to use your real payment rather than estimates that may be higher. Get written proof from your student loan servicer showing your current monthly payment, loan balance, and payment status.

• Pay down debts – Reducing credit card balances and other debts can help lower your DTI. Paying down student loans helps too, but focus first on debts with higher interest rates.

• Increase your down payment – Putting down more than the minimum 3.5% down can offset elevated debt levels in some cases.

• Pick a longer loan term – Going with a 30-year loan instead of 15-year lowers the monthly mortgage payment used in your DTI. Just be aware this increases total interest paid over the life of the loan.

• Bring in a co-borrower – Adding a co-borrower who doesn’t have student loans can improve the overall DTI for joint FHA loan applications.

• Shop around – Compare multiple lenders as rates and approval requirements can vary. Mortgage brokers can also help find you the best fit.

• Improve your credit – Payment history and credit scores matter for FHA approval too. If you have time before applying, reduce balances, pay bills on time, and correct any errors on your credit reports.

Alternatives Beyond FHA Loans

FHA loans are a great option for many buyers with student loan debt. But they aren’t the only choice. Here are a few other types of mortgages to consider:

• VA loans – For veterans and military members, VA loans offer zero down payment options and limited DTI requirements. Some lenders don’t even count student loan debt.

• USDA loans – For properties in rural areas, USDA guarantees 100% financing loans that are also less strict on DTI ratios.

• Non-QM loans – Also called “non-qualified mortgages,” these non-conforming loans look beyond FICO and DTI requirements, potentially approving higher debt. But interest rates may be higher.

• Parent PLUS loans – If parents hold PLUS loans for your education, they may qualify to remove you as the co-signer, taking the debt off your application.

• Physician mortgages – Specialized lending programs exist for doctors carrying medical school debt. They offer higher DTIs and skip some conventional requirements.

The right loan program ultimately depends on your specific situation. Be sure to talk to an experienced mortgage professional to discuss all the options.

The Bottom Line

Thanks to recent changes, FHA loans can now accommodate student debt better than they used to. This expanded access is a big win for younger, less affluent, and first-generation home buyers who rely on FHA mortgages as an affordable path to ownership.

However, approval is still not guaranteed. Having federal student loans versus private loans may improve your chances, as does keeping total debt under control. Working with a knowledgeable lender and providing full details on your student loans is key. If an FHA loan ends up not feasible, alternatives like VA and USDA loans may get you to your homeownership goals.