IBR Student Loans and Mortage: How to Get Approved

Did you know you can secure a mortgage even while on an income-based repayment plan for your student loans? Indeed, lenders have the green light to consider your monthly payment amount under various income-driven repayment plans — be it IBR, ICR, PAYE, or REPAYE. This calculation plays into your debt-to-income ratio for conventional mortgages, whether Fannie Mae or Freddie Mac backs it or if it’s a government-backed loan from the FHA or VA.

This might sound too good to be true, right?

Well, until recently, it was. Pre-pandemic, borrowers saddled with significant loan balances had to perform quite the balancing act to secure a home loan.

Here’s the old process: switch from an IDR plan to one that spreads their student loan debt over many years. This strategy typically worked out — especially for my clients with federal student loans.

But the story wasn’t as rosy for those with private student loans.

Their only path forward was to scout for refinancing opportunities with a new lender in hopes of a lower interest rate and extended repayment term — and that remains the status quo today. Keep in mind that you’ll need a good credit score and strong income to get the best refinance rates and terms.

But let’s celebrate the small victories: underwriting guidelines have taken a turn for the better. Now, homebuyers burdened with student debt can breathe a sigh of relief. Using their payment amounts under the IBR plan to get a mortgage loan approval has become a much smoother ride.

Related: Do Student Loans Affect Buying a House?

Think of your IBR student loan repayments as part of your financial baggage. They count when mortgage underwriters size up your debts to decide if they should approve your mortgage application.

How Your Debt-to-Income Ratio (DTI) is Calculated

Here’s how it works: your loan payments contribute to your debt-to-income ratio. This ratio is calculated by adding up all your monthly debt payments — credit cards, auto loans, home loans, and so on — and dividing them by your monthly income. If the ratio leans too heavily on the debt side, your loan application will likely hit a roadblock.

Related: Buying a House With $100k Student Loans

The IBR Twist

The Income-Based Repayment plan adds more complexity to the mortgage equation. Here’s why:

1. The amount you’re required to pay towards your IBR loan varies annually, fluctuating based on your adjusted gross income and family size, which together determine your discretionary income.

2. Each loan type (VA, FHA, USDA) has unique rules on how your monthly IBR-based student loan repayments factor into the mix. This poses a puzzle when working out how much you should be doling out each month and how heavily that payment should influence your DTI ratio over your 30-year mortgage term. Remember, your IBR payments may shift yearly. In certain instances, if your income dips low enough, your required payments could even drop to zero.

Navigating these dynamics requires understanding your eligibility for IBR and how your AGI and discretionary income interact with your payment obligations. It’s these intricate details that can make or break your mortgage approval.

Now, let’s shed light on the recent decisions by loan agencies regarding IBR loans in the loan qualification process:

Fannie Mae Conventional Mortgage

They’re alright with IBR payments. Their guidelines insist that you document repayment status with a credit report or loan statement. Even if your payment is $0, they’ll take it. Just remember to have documentation proving it’s zero.

Freddie Mac Conventional Mortgage

They’re flexible regarding IBR payments, but the Freddie Mac student loan guidelines are specific. If your monthly IBR payment is not reported on your credit report or is listed as deferred or in forbearance, Freddie Mac requires additional documentation to verify the monthly payment amount for calculating your debt-to-income ratio.

Suppose no monthly payment is reported on a deferred or forbearance student loan, and no documentation in your mortgage file indicates the proposed monthly payment. In that case, 1% of the outstanding loan balance will be assumed as the monthly amount for qualifying purposes.

How can you provide this proof?

Documentation could include a direct verification from the creditor, a copy of your loan agreement, or the projected payment required once deferment or forbearance ends, as shown in your loan certification or agreement.

Related: Do Deferred Student Loans Affect Getting a Mortgage?

Despite no changes in Freddie Mac’s seller guide, we’ve received direct confirmation from them: They will consider your IBR payment when determining your debt-to-income ratio. So, if your IBR payment is $0, 0.5% of your outstanding loan balance, as reported on your credit report, will be used for DTI calculations.

FHA Mortgage

The FHA rules have changed as per Mortgagee Letter 2021-13. The new FHA student loan guidelines now require including all student loans in the borrower’s liabilities, irrespective of the payment type or status.

If the payment used for the monthly obligation is less than the monthly payment reported on the borrower’s credit report, the mortgagee must obtain written documentation of the actual monthly payment, payment status, outstanding balance, and terms from the creditor or student loan servicer.

When calculating the monthly obligation for outstanding student loans, the mortgagee must use:

• The payment amount reported on the credit report or the actual documented payment when the payment amount is above zero

• 0.5 percent of the outstanding loan balance when the monthly payment reported on the borrower’s credit report is zero

VA Mortgage

The VA requires lenders to use the loan payment amount on your credit report for your DTI. But if that payment falls below a certain threshold, you’ll need to provide a statement from your student loan servicer detailing the actual loan terms. The threshold is calculated by taking 5% of the outstanding loan balance and dividing it by 12.

USDA Mortgage

Sorry, no IBR payment with USDA. Their rule book specifies your payment must be fully amortized or use 0.50% of the outstanding loan balance as shown on your credit report or the current documented payment under a repayment plan approved by the Department of Education.

New Developments

In light of the recent proposal from President Biden’s administration, these rules could see some changes soon. The new income-based repayment plan proposes to cap monthly payments at 5% of your income for undergraduate loans, which would further impact your DTI calculations.

For those of you on an Income-Driven Repayment (IDR) plan, you’re probably well aware of the unique challenges that come with applying for a mortgage. One such challenge revolves around the Debt-to-Income ratio (DTI). This ratio compares your monthly bills to your monthly earnings, measuring your ability to manage monthly payments and repay debts. Lenders pay close attention to this ratio when evaluating mortgage applications.

Understanding the DTI: A Closer Look at the Back-End Ratio

While the DTI encompasses two types – the front-end and back-end ratios – the back-end ratio tends to be the thornier issue for student loan borrowers. It includes all monthly expenses as compared to monthly income, encapsulating student loan payments and making it highly relevant to borrowers on IDR plans.

Typically, lenders prefer a back-end ratio under 41%, although they may stretch this limit depending on the applicant’s credit profile. This ratio includes:

• Current housing expenses

• Auto loan payments

• Student loan payments

• Minimum monthly payments on credit cards

• Any other debt appearing on a credit report

It does not factor in certain expenditures like utility bills, groceries, mobile phone bills, cable bills, contributions to retirement accounts, or most subscriptions.

Your IDR plan can significantly influence your DTI ratio and, by extension, your mortgage application. Since the monthly payments on an IDR plan can fluctuate based on your income and family size, these changes can affect your back-end ratio, altering your perceived financial standing in the eyes of mortgage lenders.

Strategies to Optimize Your DTI on an IDR Plan

It might seem daunting to think about decreasing your back-end DTI, but it isn’t an impossible task. Here are some strategies tailored for borrowers on IDR plans:

• Reducing Credit Card Balances: Lowering your credit card balance can improve your DTI. As your balance decreases, so does your minimum monthly payment, positively impacting your back-end DTI.

• Adjusting Your IDR Plan: Federal student loans offer a variety of repayment plans. Shifting to a different plan with lower monthly payments can potentially improve your back-end DTI.

• Paying Off Small Debts Completely: Even a low-interest debt, when paid off entirely, removes the associated monthly payment from your credit report, thereby reducing your back-end DTI.

While Parent PLUS loans aren’t typically eligible for Income-Driven Repayment plans such as IBR, there’s a trick to bypass this obstacle. It involves a strategy referred to as the “double consolidation loophole,” which might seem daunting at first but could be a game-changer for Parent PLUS loan holders in terms of mortgage applications and back-end DTI ratios.

This loophole requires two rounds of consolidation—turning Parent PLUS loans into a Direct Consolidation Loan first and then another round of consolidation with another federal loan. This smart move could potentially unlock the gates to more beneficial IDR plans like Pay As You Earn (PAYE) or Revised Pay As You Earn (REPAYE). And, as the cherry on top, it also paves the way to qualifying for student loan forgiveness programs like Public Service Loan Forgiveness.

Related: Do Parent Plus Loans Affect Getting a Mortgage?

But I can’t emphasize enough how important it is to think this through.

Loan consolidation can reduce monthly student loan payments, but it might extend your loan term, leading to higher total interest paid over time. So, consider this step carefully, understanding its impact on your IDR payments, DTI ratio, and, ultimately, your home-ownership dream.

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