Biden Actually Did Something Cool: What Student Loan Forgiveness Means for Your Home-Buying Prospects

They actually did it. It's hard to believe, but the Biden Administration will actually be forgiving some federal student loans. For many this is a big deal, and it may give them a bit of hope for their financial situation. I feel a little opportunistic to be like, oh you just got some loans forgiven? Why not go into more debt. So I’m gonna try not to be that guy. Don’t let anybody, especially me, convince you to buy a house if you don’t want a house. But IF you already want a house, you probably want to know more about it, and how this affects the viability of you getting a mortgage in the not-so-distant future. So for purely informational purposes, here’s what the Biden debt forgiveness plan means for you:

How does a mortgage lender decide how much money you qualify for?

First we take the what your projected monthly payment will be and divide it by what you make monthly (gross, not net*), this is your “front end ratio”. Then we add your monthly payment to the amount of debt payments you make every month, which we pull from your credit card. Then we divide the total amount by your gross monthly income, which gives us your “back end ratio” or your DTI (Debt to Income) ratio. Recommended front end ratio is about 28%, and recommended back end ratio is about 36%, in most cases you can’t really go over 45%. Back-end ratio kinda makes or breaks you, you can often times get away with a bad front end ratio as long as your back end is fine, or, in lay-person’s terms: “You can borrow more if you have less debt”.

How we count student loan payments

When it comes to student loans, most people right now are not paying their student loans. When covid started everyone’s loans went into forebearance and their payments were paused automatically. So unless you’ve been paying anyway (which if you wanna get that balance down, is not the worst idea) you are not. However, when you go for a mortgage we have to count all your student debt as though you ARE paying it, because you will be required to at some point. So if we look at your credit report and see you have $50,000 in student loans, with no payment, Fannie Mae would require us to count 1% or $500 as a payment. (Freddie Mac requires 0.5% or $250 in this example).

So with $10,000 less in student debt, you can just divide that by 100, and you get $100. So that means you can afford a mortgage payment that is $100 higher than you otherwise could. Most mortgages are paid in 30 years, so if interest weren’t a thing you could just multiply $100 by 360 months and get $36,000. It gets more complicated with interest rates but at the average interest rate as of writing this, 5.55% you would qualify for about $18,500 more than you otherwise would. Now if you are a Pell Grant Recipient, I believe the forgiveness is doubled to $20,000, which would boost you about $37,000 over what you could afford without it. Neither of these is a whole house, but it could certainly take you across the finish line if you’re almost there!

What about my credit score?

One thing you might have heard is that paying off a student loan can actually make your credit score go down. This is why: Your credit score is based on 5 things (best read to the tune of Remember The Name by Fort Minor):

·???????35% Payment history (how faithfully you’ve made payments in the past),

·???????30% credit utilization (using responsible amounts of the credit you have access to),

·???????15% credit history (average length of time each account you have has been open, the longer the better)

·???????10% Credit Mix (the diversity of your accounts, between credit cards, retail accounts, installment loans, finance company accounts and mortgages)

·???????10% New Credit (while opening up a brand new account here and there won’t hurt you, opening several at once will.

Source: https://www.myfico.com/credit-education/whats-in-your-credit-score

You usually can’t open a credit account until you are 18, meaning most peoples oldest credit accounts are their student loans. Since you don’t HAVE to get a credit card or a car loan or whatever when you’re 18 but a lot of people do HAVE to get student loans, it’s possible there may be a decent age gap between your student loans and other credit accounts. When you pay off a loan early it closes that account, and if that was the oldest thing in your credit, it could have a noticeable negative effect on your credit.

There are a few reasons why I don’t think this that big of a deal:

1. ?$10,000 and even $20,000 is not gonna close most people’s student loan accounts
2. If you have been paying off your loans faithfully enough to only owe $10,000 and you have aspirations of owning a house some day, you are probably credit-minded enough to have plenty of other responsible credit activity to keep your score up
3. Simply not having enough credit/credit history is the easiest credit problem to fix. Just get a credit card (secured if you can’t get a regular one), make regular payments, and keep a balance of $10-$20 each month for fastest results.

The other thing about this program is that it automatically brings everyone’s student loans current, so while there is a concern that it might drop some folks credit a few points it will definitely help more people than it hurts, and the damage it does is easily correctable. In fact, if this messes up your score, call me (484) 416-5782 and I will tell you exactly how to fix it.

Why student debt is especially heinous

Now to my initial point that maybe people aren’t chomping at the bit to get more debt as soon as the other debt is forgiven, fair point. I will say though, that not all debts are created equal. Student debt is especially egregious because there’s not really any way out of it. If you didn’t need your house or car any more and wanted to stop paying for it you could sell it or stop making the payments and have the bank take them away. How many times have you heard people say they don’t use their degree in their current job? If I could default on my student loans, and have my Bachelor of Arts in Advertising taken away I gladly would (no offense to my many wonderful teachers and classmates still following me on LinkedIn). That’s not an option. If you default on your student loan they can garnish your wages, take your tax returns, and all sorts of other fun stuff. Even if you declare bankruptcy, only in specific cases can you get your student loans discharged as a result of that, and you will need to argue your case with a lawyer , a certain American president saw to that but I can’t knock him for trying to improve his SEO when you google "Joe Biden Student Debt."

How they're fixing the WORST thing about Student Debt

There is one other really nasty thing about student loans that the new plan intends to correct, though. That is that many “income-driven repayment plans” (IDRs), which sounded like a nice fair way of managing payments, by making payment amounts be a portion of the individual’s income. However, it wouldn’t actually change anything about the terms of the loan. So if you’re paying less than the interest, as many with very high balances of loans do, the remaining interest is added to the principal. This lead to nightmare stories of folks faithfully paying their IDR only to find their balance GO UP as they paid. It’s called "Negative Amortization", it is one of the only situations in which this is even legal, and it is DEFINITELY predatory. Biden’s new plan apparently aims to fix this by having the federal government cover interest on loans under income-based repayment plans. It also changes the definition of “non-discretionary income” from $20,000 to $31,000, meaning if you make $31,000 or less you will pay $0, a month without accruing interest. And you only need to pay 5% of your “discretionary income” above that.

That is pretty phenomenal as far as ending the predatory practices on income-based repayment plans goes. From a mortgage perspective it raises an interesting opportunity with one unfortunate caveat. If you were on an income-based payment plan, you could count the payment instead of the percentage of debt, which if you make less than $31,000 a year would be $0. The caveat: you can only do that on a conventional loan. FHA, the federal government’s program for lower income borrowers, ironically does not allow you to count income-based repayment plans. So you will need at least 5% down as opposed to the 3.5% down you could do with FHA. If you are low-income, this could definitely be the difference between you qualifying and not qualifying.

What should you yell at Joe Biden if you see him?

“More!” is a good start. It’s important to remember that the federal government can forgive federal loans whenever they want (see the PPP loans issued at the start of the pandemic, the small business administration has forgiven $742 billion of the $793 billion in loans it had approved https://projects.propublica.org/coronavirus/bailouts/). There are many hardworking people who have who have six digit student loan balances that will loom over them for the rest of their lives. To many of them, 10-20k is about as good as a slap in the face. Always ask for more. A more likely slam dunk for the administration would be to change the FHA guidelines to allow income-driven repayment plans, making the weight of these loans bear less on their ability to purchase a home and build wealth. Frankly I’m not sure why the FHA doesn’t allow this already, but it wouldn’t hurt to yell that at Joe Biden or HUD Secretary Marcia Fudge.

Call Me If You Get Lost

If you couldn’t tell, qualifying for a loan can get a little complicated, but there are a bunch of little rules in the fine print that can make things much easier for certain buyers. That’s why you need a lender who has a handle on this sort of thing, has a very experienced team, and isn’t afraid to hit the books to dig up the best info. ?Also I am that, so call me.

-Joe