Can You Buy a House With Defaulted Student Loans?

You can qualify for a mortgage even with defaulted student loans, whether they are federal or private.

Several mortgage options are available to you, including FHA and other federally backed mortgages like USDA and VA, as well as conventional mortgages backed by Fannie Mae. But remember one thing.

You typically need to clear your defaulted status first, especially in a federal database known as CAIVRS.

Ahead, we’ll explore practical strategies and tools that can empower you on this journey. Even with defaulted student loans, owning a home can become your reality.

Related: Do Student Loans Affect Buying a House?

Yes, you can get a conventional loan with defaulted student loans. Although defaulted student loans can create challenges, they don’t automatically disqualify you from getting a conventional loan.

But understanding the nuances between different types of loans is critical.

Here’s the breakdown:

Federally Backed Mortgages vs. Conventional Loans

Federally backed mortgages are government-guaranteed loans. That includes FHA, USDA, and VA loans. Conventional loans, on the other hand, aren’t. This means the lenders bear the risk if a borrower fails to pay back, which often results in stricter requirements:

• Higher credit score

• Larger down payment

• More stable income

Applying with a Default on Your Credit Report

If your defaulted student loan appears on your credit report, lenders typically ask for a letter of explanation. This should detail:

• The reasons for the default

• Actions you’ve taken to rectify it

Applying with No Default on Your Credit Report

If your defaulted loan doesn’t show up on your credit report, you may still qualify for a conventional loan, provided you meet the lender’s requirements, which often include:

• Credit Score: Conventional loans typically require a higher credit score. The exact score can vary, but many lenders prefer a score of 620 or higher.

• Debt-to-Income Ratio (DTI): DTI ratio measures your monthly debt payments against your gross monthly income. Lenders often prefer a DTI of 43% or less, although some may allow a higher ratio with strong compensating factors.

• Employment History: Lenders typically like to see at least two years of steady employment. They may verify this through pay stubs, tax returns, or employer contact.

• Down Payment: While you can get a conventional loan with as little as 3% down, a larger down payment could help you secure better terms.

• Sufficient Assets: Lenders want to see that you have enough assets to cover down payments, closing costs, and several months of mortgage payments.

The Impact of Default Timing

In times of recent defaults, high inflation, and their effects on credit scores, it becomes incredibly challenging to secure a conventional loan.

• Credit Score: A credit score of 620 or higher is recommended for a conventional mortgage. But achieving a score of 740 or above is ideal as it can qualify you for better mortgage rates and terms. A higher score can improve your chances of securing a mortgage with more favorable terms and lower interest rates.

• Inflation: Inflation doesn’t just affect the economy at large – it can directly impact your mortgage application. It can lead to heightened lending requirements, making it harder for applicants, especially those with defaulted student loans, to get approved. It can also result in higher mortgage interest rates, as it devalues the U.S. dollar, reduces demand for mortgage-backed bonds, and incurs higher monthly home loan payments. Further, the Federal Reserve may hike interest rates in response to inflation, adding to the cost of borrowing.

• Managing Your Situation: Given these challenges, managing your credit by monitoring your credit score and checking your credit report for defaulted student loans is essential.

No, you’re typically not eligible for an FHA loan if you default on a student loan or any other debt to a federal agency. The Federal Housing Administration uses CAIVRS, a government database that monitors credit delinquencies and defaults, to help implement this policy.

Related: FHA Student Loan Guidelines

If your defaulted student loan is listed on a CAIVRS report, it may bar you from receiving an FHA loan.

But if a defaulted federal student loan under your name is inaccurate, you will need to address this with the Education Department.

That said, the “Fresh Start” program, a recent initiative by the U.S. Department of Education, helps first-time homebuyers avoid battling the CAIVRS system.

Fresh Start Program and FHA Loans

Introduced in April 2022, the Department of Education Fresh Start Program aims to lessen the negative impacts of default for borrowers with defaulted federal loans.

One of its many benefits is restoring the eligibility for Federal Student Aid and removing borrowers from the CAIVRS database. This can subsequently increase the accessibility to FHA loans for student loan borrowers.

To buy a home while managing defaulted student loans, consider three primary strategies:

• Loan rehabilitation

• Loan consolidation, or

• Full repayment or negotiate a settlement.

For a temporary period, the Fresh Start program can also be an option for defaulted federal student loans.

Regardless of your chosen strategy, the default record will remain on your credit report for seven years. This could impact your access to credit cards, personal loans, and other financial products during this time.

Each of these strategies has its own benefits and drawbacks, making it critical to assess your financial situation to determine the best fit. Let’s take a closer look at each option.

Strategy #1: Loan Rehabilitation

Loan rehabilitation is a process requiring you to make nine consecutive on-time payments within a 10-month period. Successfully completing this process can restore your access to deferment, forbearance benefits, and repayment plans lost due to default. This strategy can positively affect your credit history as the default record will be removed, but any late payments reported by the loan holder before the default will stay.

Loan rehabilitation can benefit borrowers with defaulted federal student loans, allowing them to regain eligibility for government-backed mortgages like FHA loans. Keep in mind that loan rehabilitation can take up to nine months to complete, requiring your patience and commitment to making timely payments.

Strategy #2: Loan Consolidation

Loan consolidation involves merging multiple loans into one. It can be especially helpful for borrowers with defaulted student loans, as it may enable them to qualify for forgiveness and payment modifications. For consolidation eligibility, borrowers must have at least one loan that has yet to be previously consolidated. Additionally, they should agree to pay the consolidated loan through an income-driven repayment plan or by making three full monthly payments before applying for consolidation.

Although loan consolidation is typically faster than loan rehabilitation, taking around 30-90 days to complete, each option’s pros and cons should be weighed before deciding. For example, while loan consolidation can help reestablish deferment, forbearance, and loan forgiveness eligibility, it may not improve your credit history as much as loan rehabilitation.

Related: Should I Consolidate My Student Loans Before Buying a House?

Strategy #3: Full Repayment or Settlement

Full repayment involves clearing the outstanding student loan balance, including interest or fees. On the other hand, settlement is a process where you negotiate a lower payoff amount with the lender in exchange for a lump-sum payment.

Both options can resolve defaulted student loans and improve your chances of securing a mortgage loan. But late payments will persist even after paying the student debt off.

When contemplating full repayment or settlement, it’s crucial to assess your financial situation carefully and determine which option suits you best. While full repayment is the most effective solution to eliminate a default, settlement can provide a more affordable alternative for borrowers who might not have the resources for full repayment.

Strategy for Private Student Loans

For private student loans, the situation is different. Usually, the only way to resolve a defaulted private student loan is to negotiate a settlement with the lender.

Most private lenders don’t offer loan rehabilitation programs, and consolidating or refinancing student loan debt typically isn’t an option. This is because defaulting on your payments shows you’re a credit risk, which student loan refinance lenders want to avoid. That said, a lender called Yrefy specializes in refinancing defaulted private student loans, providing a potential option for would-be homeowners in this situation.

Related: Will Cosigning a Student Loan Affect Me Buying a House?

Importantly, if a defaulted private student loan no longer appears on your credit report with any of the three major credit bureaus, it typically won’t create a problem when applying for a mortgage. This is because there is usually no other record for the underwriting team to find a defaulted private loan if it’s not on your credit report.

Choose the Best Strategy For You

Remember that each of these strategies has its own benefits and drawbacks, and your unique financial situation will guide you to the best fit.

Despite these options, the record of default will remain on your credit report for seven years, potentially impacting your access to credit and mortgage loans during that time.

For more in-depth information on how defaulted student loans can lead to a mortgage denied due to student loans, consider reviewing our comprehensive guide on this topic.

Qualifying for a mortgage with student loans in default is tricky. While some realtors and mortgage lenders think it’s impossible, it’s not. You can navigate the complexities of your student loan payments, negotiate your defaulted loans, and still make your dream of homeownership a reality.

The most important step is taking action on your defaulted loans, whether through loan rehabilitation, consolidation, or full repayment. Then, you can rebuild your credit and improve your financial standing. In doing so, you increase your chances of obtaining a mortgage loan amount that suits your needs and fits within your personal finance plan. Remember that your persistence and proactive steps will pave the way to your future home.