Navigating Student Loans When Applying for a USDA Home Loan

Student loans can complicate the home buying process but they don’t have to stop you from becoming a homeowner. If you have student loans and are considering applying for a USDA home loan this guide will walk you through everything you need to know.

What is a USDA Loan?

USDA loans, also known as United States Department of Agriculture loans, are a great option for low-to-moderate income homebuyers in rural areas. These government-backed loans require no down payment and have competitive interest rates

To qualify for a USDA loan, the home you want to buy must be located in an eligible rural area. The USDA has an eligibility map you can check to see if the home you’re interested in falls within their service area.

In addition to location requirements, USDA loans have income limits. Your household income must be below the limit for your area, which varies by county and household size. The USDA has an income eligibility tool on their website to see if you qualify.

How Student Loans Impact USDA Loan Eligibility

When you apply for any mortgage, the lender will assess your debt-to-income (DTI) ratio. This measures your monthly debts compared to your monthly income. Most lenders like to see your DTI below 41% to qualify.

Your student loan payment will be included in your DTI calculation when applying for a USDA loan. This means the higher your student loan payment, the harder it may be to get DTI below 41%.

Here’s how the USDA requires lenders to calculate your monthly student loan payment when figuring your DTI:

• For federal student loans on an income-driven repayment (IDR) plan, lenders must include either 0.5% of your total student loan balance or your actual IDR payment amount documented on your credit report – whichever is greater.

• For student loans on a standard 10-year repayment plan, lenders can use your fixed monthly payment amount.

As you can see, IDR plans don’t always help lower your DTI as much as you might expect when applying for a USDA home loan. Even with an IDR plan, your payment is still calculated based on your total student loan balance.

Strategies to Get USDA Loan Approval With Student Loans

If your student loans are making it hard to get under the 41% DTI limit for a USDA loan, here are some strategies that can help:

• Make extra payments to pay down balances – This will reduce the 0.5% calculation and your overall DTI.

• Refinance student loans to lower interest rates – May allow you to get a lower fixed monthly payment amount that can be used.

• Get on an extended repayment plan – Can sometimes have lower monthly payments than IDR plans.

• Apply with a co-borrower – Adding another borrower combines your incomes and could improve DTI.

• Use household income, not individual – USDA allows combined household income from all working adults, which can help DTI.

• Compensating factors – A good credit score, significant cash reserves, and moderate total student loan debt compared to income can sometimes outweigh a high DTI.

The key is working with an experienced USDA lender who understands how to position your student loans to meet the program guidelines. They can guide you through the most effective strategies based on your unique situation.

What if My Student Loans Are in Deferment or Forbearance?

If your federal student loans are in deferment or forbearance, meaning your monthly payment is currently $0, how does this work when applying for a USDA home loan?

In this scenario, the lender will use 0.5% of your total student loan balance to calculate your monthly payment amount for DTI purposes. Payments are never counted as $0 when it comes to mortgage qualification, even if that’s what you actually pay right now under deferment or forbearance.

Once your deferment/forbearance period ends, you will be responsible for making monthly payments again. Be sure to budget for this when determining how much house you can afford with a USDA loan.

Some first-time home buyers have run into trouble because they bought a home while their loans were deferred, but didn’t account for payments restarting. Make sure you fully understand when your deferment period will end and what your monthly commitment will be.

Special Rules for Medical and Dental Residency Loans

If you have student loans from medical or dental school residency, they may be eligible for special treatment when applying for a USDA home loan:

• Medical/dental residency loans can be excluded from your DTI calculation if you’re able to provide documentation that a deferment will be granted for at least 12 months after closing on the mortgage.

• Residency loans can also be excluded from DTI if you are currently in a deferment period that will last at least 12 months from the time you apply for the loan.

In these cases, the lender does not need to count a 0.5% payment for those specific student loans. This can really help lower your ratios.

Just make sure you retain documentation of the deferment and provide it to the lender. They will need to verify the deferment terms with your student loan servicer.

Options for Home Loans Besides USDA

Some alternatives to consider if your student loans make it too difficult to qualify for a USDA loan:

• FHA loans – Require just a 3.5% down payment and have more flexible DTI standards. May be able to use your actual IDR payment amount to calculate your student loan payment for DTI purposes.

• VA loans – Offer 100% financing with no down payment for veterans and service members. VA does not include your student loan payment in your DTI calculation.

• Conventional 97 mortgage – Allows 3% down payment on conventional loan with private mortgage insurance. Has guidance allowing your IDR payment to be used regardless of loan balance.

• Low down payment conventional loans – May have better options for counting IDR payments than USDA, even with PMI.

• State/local down payment assistance programs – Subsidized second mortgage helps cover down payment allowing conventional loan with more ideal student loan rules.

The bottom line is that student loans can make buying a home more tricky, but they shouldn’t stop you from achieving your dreams of homeownership. Be persistent, explore programs like the USDA and other mortgage options, work with an experienced loan officer, and employ smart strategies to overcome student debt challenges. You can do this!