Student Loans and Buying a Home: What the July 1 Deadline Could Mean for You

The Short Version

If you have federal student loans and are considering buying a home in Newton, Kansas, the repayment plan you select after July 1 could impact your mortgage eligibility.

Why This Matters

Lenders factor in your student loan payments when calculating your debt-to-income ratio, or DTI. This ratio plays a significant role in determining how much home you can afford. Therefore, your choice regarding student loans is also a homebuying decision.

At NEO Home Loans powered by Better, we believe that the mortgage process should start with education, not pressure. Here’s what you need to know before making a decision.

What’s Changing on July 1?

Beginning July 1, the repayment options for federal student loans will change.

The most notable change is the discontinuation of the SAVE plan. Borrowers currently enrolled in SAVE will need to select a new repayment plan. If they do not, they may be automatically transitioned to another plan.

Two options are anticipated to gain prominence:

Repayment Assistance Plan (RAP)
This plan adjusts your payments based on your income. For some borrowers, this could lead to a lower monthly payment.

Tiered Standard Plan
This option utilizes fixed payments based on your original loan balance. While it may be simpler, it could also result in a higher monthly payment.

Some borrowers already enrolled in Income-Based Repayment (IBR) may have the option to remain in that plan for a limited time.

Why This Matters if You Want to Buy a Home

When you apply for a mortgage, lenders examine both your monthly income and your existing financial obligations. This includes credit card debt, car loans, personal loans, student loans, and your future mortgage payment. Together, these factors contribute to your DTI.

If your student loan payment increases, your DTI rises, potentially lowering your purchasing power. Conversely, if your student loan payment decreases and is properly documented, your buying power may improve. This is why selecting the right repayment plan is crucial.

The Part Many Borrowers Miss

Even if your student loan payment is currently $0, a mortgage lender may not treat it as such. In certain situations, lenders may use an estimated payment instead. A common approach is to calculate 0.5% of your total student loan balance.

For instance, if you owe $60,000 in student loans, a lender might consider $300 per month against you when evaluating your mortgage eligibility. This can significantly impact your application.

Before assuming your student loans will not influence your mortgage application, ensure you understand how your lender will account for them.

RAP, IBR, or Standard: Which Plan is Best for Buying a Home?

There is no universal answer to this question. The best repayment plan is contingent on factors such as your income, loan balance, family size, timeline, and the type of mortgage you are applying for.

Generally, RAP may be advantageous if it results in a lower documented monthly payment than what the lender would otherwise use. IBR may be beneficial if you are already enrolled and your payment is low or $0, particularly if you are applying for a conventional loan. The Standard repayment plan may be suitable if you prefer a fixed, easily documented payment and your income can support it.

The key point is documentation. A low payment will only assist your mortgage application if your lender can verify and utilize it.

FHA and Conventional Loans May Treat Student Loans Differently

This aspect is important. Conventional loans may offer more flexibility when considering an income-driven repayment amount, especially if it is well documented. FHA loans tend to be stricter; often, FHA lenders will use either your documented payment or 0.5% of your student loan balance, whichever is higher.

This means two buyers with identical income and student loan balances could qualify differently based on the loan program. It is advisable to discuss your options before selecting a repayment plan or applying for a mortgage.

What Should You Do Before July 1?

Start with these four steps:

First, check your current repayment plan. Log into your student loan account to confirm your existing plan, balance, and required monthly payment. If you are on SAVE, pay close attention to any communications from your loan servicer.

Second, perform the 0.5% test. Multiply your total student loan balance by 0.5%. This will provide a rough estimate of what a lender may count if your payment is deferred or not adequately documented.

Third, compare your payment options. Evaluate RAP, IBR if available, and the Standard Plan. Do not simply choose the lowest payment you find online; consider how that payment may impact your mortgage qualification.

Finally, consult with a mortgage advisor before making any significant changes. Adjusting repayment plans, refinancing student loans, or applying for a mortgage can all interrelate.

A Quick Example

Let’s assume you owe $60,000 in federal student loans. A lender using the 0.5% calculation may count $300 per month in student loan debt. If your new repayment plan leads to a documented payment of $150 per month, that lower payment could improve your DTI. However, if your documented payment is $500 per month, your purchasing power may be less than anticipated.

This illustrates that the right plan is not necessarily the one that sounds the best. It is the one that aligns with your overall financial situation.

Frequently Asked Questions

Can I buy a home if I have student loans? Yes, student loans do not automatically prevent you from purchasing a home. Lenders simply need to understand how the payment fits into your financial picture.

Will a $0 student loan payment help me qualify? Possibly. Some loan programs may accept a documented $0 payment, while others might still account for a percentage of your balance. Confirm how your lender will approach this.

Should I switch repayment plans before applying for a mortgage? It is advisable to consult a mortgage advisor first. Changing plans can impact your documentation, credit report, and qualifying payment.

Is RAP better for mortgage approval? It depends. RAP can be beneficial if it lowers your documented monthly payment, but for higher-income borrowers, it may result in a higher payment than expected.

Should I refinance my student loans before buying a home? Proceed with caution. While refinancing might reduce your payment and improve your DTI, moving federal loans to private loans can eliminate federal protections. Consider the full implications before making a decision.

The Bottom Line

Your student loan repayment plan can significantly influence your mortgage approval, DTI, and purchasing power. However, with careful planning, it does not have to derail your homeownership aspirations.

Before July 1, take some time to review your student loan options and consult with a mortgage advisor who can help you understand the numbers.

At NEO Home Loans powered by Better, our mission is not only to assist you in obtaining a loan but also to empower you to make informed financial choices that support your long-term financial health.

Ready to evaluate your options? Start your online pre-approval with NEO Home Loans powered by Better and gain a clearer understanding of your homebuying potential in just minutes, without affecting your credit score.