Mortgage Denied Due to Student Loans? Here's What to Do

Worried you’ll be denied a mortgage due to student loans? You’re not alone.

As of 2023, student loan debt in the U.S. totals $1.7 trillion, placing considerable strain on potential homeowners. Indeed, student loans can be a significant impediment to securing a mortgage, largely due to their impact on key factors like your debt-to-income (DTI) ratio and credit score.

Yet, despite this daunting landscape, emerging shifts in the 2023 housing market and evolving lending guidelines signal hope for those burdened with student debt.

In this article, we delve into the complex intersection of student loan debt and homeownership, explore the recent changes in lending policies, and provide a comprehensive overview of the current housing market.

We’ll also discuss why student loans can lead to mortgage denials and what steps you can take to improve your chances of homeownership despite your student debt.

Related: Do Student Loans Count Towards DTI?

If you’ve been denied a home loan because of student loan debt, including federal student loans or private student loans, don’t lose hope. There are several strategies that can help improve your chances of pre-approval on your next application:

• Understand the Reason for Denial: During the underwriting process, lenders are legally obligated to provide a specific reason for your mortgage application denial. If high student loan debt is the problem, it’s likely impacting your Debt-to-Income ratio, which is a critical metric lenders use to assess your ability to manage monthly debt payments, such as a mortgage payment.

• Lower Your DTI Ratio: Your DTI ratio is the percentage of your gross monthly income that goes towards paying debts, including student loans, auto loans, credit card debt, and other financial obligations.To enhance your chances of securing a conventional loan or other types of loans: (1) Increase your income: Seek opportunities for a higher-paying job, a second job, or freelance work; and (2) Decrease your debt: Pay off smaller debts, make extra payments on your student loans, or consider refinancing your student loans for a lower monthly payment.

• Adjust Your Student Loan Repayment Plan: If you’re on an Income-Driven Repayment Plan like Income-Based Repayment (IBR), and your payment is $0, consider getting a non-zero payment. This allows your lender to use this amount for the DTI calculation during the underwriting process.

• Improve Your Credit Score: A robust credit history can counterbalance a high DTI ratio. Improve your credit score by paying all your bills on time, keeping your credit card balances low, and avoiding new credit accounts unless necessary.

• Consider Different Loan Types: Different types of loans come with varying requirements. Government-backed loans, like FHA or VA loans, often have more lenient lending requirements, which may be beneficial if you’re struggling with student loan debt.

• Consult with a Credit Counselor or a Financial Advisor (NMLS certified): Personal finance professionals can provide tailored advice, helping you devise a plan to improve your chances of loan approval, even in the context of potential student loan forgiveness programs.

• Consider Finding a New Lender: Not all lenders or mortgage brokers keep up-to-date with changes in lending regulations, which have been evolving especially in the Biden administration and throughout the pandemic. If your loan has been denied, consulting with another lending professional who holds an NMLS certification could offer a fresh perspective or approach to your situation.

• Reapply: After you’ve taken steps to better your financial standing, don’t hesitate to reapply for a home loan. The goal is to prove to lenders that you can consistently handle the loan amount and make your mortgage payment on time.

Remember, a denial is not a permanent roadblock but an opportunity to reassess your financial state and make necessary improvements.

With patience, persistence, and well-informed financial decisions, you can navigate the real estate market, manage your closing costs, and make a down payment on your dream home, overcoming the hurdle of student loan debt.

Related: Buying a House With $100k Student Loans

Student loan debt can be a significant obstacle to homeownership.

But updates to existing programs and policies, as well as proposed new ones, aim to lift this burden and make getting a mortgage easier for borrowers.

Existing Programs and Policy Updates

Government-backed loan programs such as those from the Federal Housing Administration (FHA), Fannie Mae, Freddie Mac, VA, and USDA have been revised in response to the student loan crisis.

Here’s how these changes can assist prospective homebuyers grappling with student loan debt:

Federal Housing Administration Loans

In a considerable shift to aid lower-income borrowers and narrow the racial gap in homeownership, the FHA has relaxed its stance on student loan debt.

Learn More: FHA Student Loan Guidelines

Previously, the FHA program assumed borrowers were making monthly payments equal to 1% of their outstanding student loan balances. This calculation often inflated a borrower’s debt-to-income ratio, disqualifying otherwise creditworthy borrowers from FHA loans.

The new policy has abandoned the 1% assumption in favor of a calculation that better mirrors actual monthly payments. This adjustment is expected to significantly assist individuals across the nation and promote equity and opportunity in homeownership.

Fannie Mae Loans

Fannie Mae has updated its guidelines concerning student loan debt. If a monthly student loan payment is provided on the credit report or the student loan documentation, lenders can use that amount for qualifying purposes.

If the borrower is on an income-driven payment plan with a $0 monthly payment, the lender may qualify the borrower with a $0 payment.

For deferred loans or loans in forbearance, the lender may calculate a payment equal to 1% of the outstanding student loan balance or a fully amortizing payment using the documented loan repayment terms.

Freddie Mac Loans

Freddie Mac’s student loan guidelines require that all the borrower’s debts incurred through the note date be considered when qualifying the borrower.

For student loans in repayment, deferment, or forbearance, if the monthly payment amount is greater than zero, lenders use the monthly payment amount reported on the credit report or other file documentation.

If the monthly payment amount reported on the credit report is zero, lenders use 0.5% of the outstanding loan balance.

Related: Buying a House With Student Loans in Deferment

VA Loans

For VA loans, if the student loan is in deferment for at least 12 months beyond the closing date, the monthly payment does not need to be considered by the lender.

If the loan is in repayment or scheduled to begin within 12 months from the date of VA loan closing, the lender must consider the anticipated monthly obligation.

Typically, lenders calculate this by taking 5% of the outstanding student loan balance and dividing it by 12.

If the credit report shows a higher payment, the lender must use the payment reported on the credit report. But if the reported payment is lower, the loan file must contain a statement from the student loan servicer reflecting the actual loan terms and payment information.

USDA Loans

For USDA loans, lenders must use the payment amount from the credit report or the documented payment if it’s above zero. But if the payment amount is zero, then lenders use 0.5% of the outstanding loan balance from the credit report or creditor verification.

This applies to all student loans, including those in “forgiveness” plans or programs and those paid by another party but in the applicant’s name.

Proposed Policy Solutions

In addition to these changes, there are proposed policy solutions designed to further address the student loan debt issue.

One significant proposal is the Transforming Student Debt to Home Equity Act of 2022.

This bill, which has not been signed into law, aims to allow first-time homebuyers to roll their student loan debt into a mortgage loan, providing a pathway to homeownership for those burdened by student loan debt.

While these existing and proposed policy updates are promising, there is still work to be done to eliminate the barriers to homeownership that student loan debt creates. Efforts must keep evolving and expanding to meet the needs of those burdened by student loan debt.

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

Navigating student loan debt while pursuing homeownership can be a lifelong burden.

With the right knowledge and tools, however, it’s a challenge you can confidently tackle.

Our team specializes in helping individuals find strategies for managing student loans while pursuing homeownership dreams.

Don’t let student loans stand in the way — book a call today to develop a personalized strategy that acknowledges your student loans and leads to owning your dream home.