3 Mortgage Hacks to Help Pay Off Your Student Debt
Fannie Mae, the government-controlled entity that buys most of the nation’s mortgages from lenders to make home loans more available to consumers, has created a way to make it easier for homeowners to use cash-out mortgage refinances to lower student debt. It has also modified two rules to make it easier for would-be homeowners with student loan debt to qualify for a mortgage. The changes became effective April 25, 2017.
The new guidelines also apply to those who have cosigned on a student loan or borrowed on a student’s behalf – most often a parent. This change is particularly helpful to those with private student loans, which commonly require a cosigner.
How Cash-Out Mortgage Refinancing Lowers Student Debt
Refinancing student loan debt with mortgage debt can make sense in today’s market, when the national average interest rate on a 30-year fixed-rate mortgage is around 4% and borrowers may have student loans with rates as high as 8.25% for federal Stafford and PLUS loans taken out since 2000. Private student loan rates can be in the low two digits (e.g., 12.25%).
Average student loan debt is $30,100 per borrower, according to the Institute for College Access and Success, and 68% of graduates from public and nonprofit colleges in 2015 had student loan debt. State averages are as high as $36,101, in New Hampshire, and as low as $18,873, in Utah. (For more, see The States With the Worst Student Debt (and Debtors).)
Fannie Mae’s New Program Makes Things Easier
Fannie Mae’s new student loan cash-out refinance, which may be available through any of the 1,800 lenders nationwide that sell loans to Fannie Mae, allows existing homeowners to use their home equity to pay off student loan debt. Borrowers must pay off at least one student loan in full; partial repayment of student loans is not allowed.
The lender will use the loan proceeds to pay off the student loan(s) directly when the loan closes. And because this program is a limited cash-out refinance intended exclusively to pay off student loans, the borrower can only receive the lesser of 2% or $2,000 above the student loan payoff amount at closing. Borrowers are generally not eligible for a cash-out refinance unless they have owned the home for at least six months.
The borrower completing the refinance must be personally obligated for the student loans. If a husband and wife’s home was mortgaged to the husband only and refinanced to the husband only, he could not use the transaction to pay off his wife’s student loans through this program (though he could use a regular cash-out refinance to do so).
Fannie Mae’s standard cash-out refinance requirements for loan-to-value, combined loan-to-value, and home equity combined loan-to-value ratios apply. For a single-family principal residence, the maximum for all three is 80% for a fixed-rate mortgage and 75% for an adjustable-rate mortgage. This means that after completing the refinance, the borrower must still have 20% equity in the home if obtaining a fixed-rate mortgage and 25% equity in the home if obtaining an adjustable-rate mortgage.
For example, let’s say your home is worth $300,000 and your mortgage balance is $200,000. Your home equity is $100,000 divided by $300,000, or 33%. Your loan-to-value ratio is 67%. You can get a new, fixed-rate mortgage for up to 80% of $300,000, which is $240,000. With that $240,000, you would pay off your old $200,000 mortgage and put the other $40,000 toward full repayment of one or more student loans.
A typical cash-out refinance comes with what’s called a “loan-level price adjustment,” which means that a certain percent is added to your interest rate depending on what your loan-to-value ratio will be after the refinance and what your credit score is. With an excellent credit score of 740, for example, you would typically have 0.875% added to your interest rate if you were doing a cash-out refinance with an 80% loan-to-value ratio, and you would have 1.750% added to your interest rate with a credit score of 680. For the student loan cash-out refinance, this price adjustment will not apply, resulting in a significant savings even for the most credit-qualified borrowers.
Count Your Actual Student Loan Payment
In deciding whether an applicant is qualified, mortgage lenders may now use an applicant’s actual monthly payment under an income-based repayment plan, in which more than five million borrowers participate, as noted on credit reports. This rule change makes sense, because the borrower’s student loan payment will only increase if his or her income increases, and thus a higher student loan payment shouldn’t affect the borrower’s ability to pay the mortgage.
If the applicant’s monthly student loan payment doesn’t appear on a credit report or is reported as zero, however, the lender must still use 1% of either the remaining student loan balance or the monthly payment that will fully pay off the loan by the end of its documented repayment term — the same calculation method that hurt many applicants under the old guidelines.
Exclude Debts Paid by Someone Else
Another big change is that if an applicant can document that someone else, such as a parent, has been making payments on a non-mortgage debt, such as a credit card or an auto loan, for the last 12 months, that debt can be excluded from the applicant’s debt-to-income ratio, even if the payer isn’t a cosigner to the loan.
Suppose your lender allows a maximum debt-to-income ratio of 36%. If your monthly income is $6,000, and the monthly debt payments that show up on your credit report are $3,000, your debt-to-income ratio of 50% would be too high to qualify you for a mortgage. Now suppose that Mom and Dad have been paying $1,000 of your monthly $3,000 debt obligations for the last two years, because it was the only way you could afford to move out and accept that job you were finally offered. If they can document those payments to the lender’s satisfaction, the lender will consider you to have a debt-to-income ratio of just 33% ($2,000/$6,000), and you’ll have a qualifying ratio.
The Bottom Line
With debt paid by others excluded from an applicant’s debt-to-income ratio and more-generous and more-realistic student-loan-payment calculations, more would-be homeowners with student loan debt should be able to qualify for a mortgage. Further, Fannie Mae’s new guidelines mean that more existing homeowners with student loan debt should be able to refinance and pay off higher-rate student loan debt with lower-rate mortgage debt. (For more, see Student Loans: Paying Off Your Debt Faster.)