Government-backed loan can be tough with student loans

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A borrower-friendly FHA loan can be a godsend if you're just starting out and don’t meet the tougher requirements of a conventional mortgage.

FHA mortgage loans, which are insured by the Federal Housing Administration, allow down payments as low as 3.5% and have no minimum or maximum income requirements for borrowers. But there are other guidelines that must be met.

  • You'll need to show a credit score of at least 500. If you haven’t seen your score lately, it's very easy these days to get a peek at your credit score for free.

  • You must have a credit score of 580 or higher to make the minimum 3.5% down payment. If your score is lower, you’ll need to put 10% down.

  • Your debt-to-income — or DTI — ratio must be 50% or less. A DTI ratio is a tool lenders use to determine whether they believe you can manage a mortgage payment in addition to your existing debts.

That last one gets tricky when a borrower has outstanding student loans.

Why student loans can get you turned down for an FHA loan

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Say you have $100,000 in student debt but you’re on an income-driven repayment plan and are paying only $200 per month on your loan.

When determining your DTI ratio, a lender is required to factor in a monthly payment for your student loan, using either the payment amount noted on your credit report or 1% of the remaining loan balance — whichever is greater. And 1% of $100,000 would be $1,000 — a hefty payment to meet each month.

That math often wipes out a borrower’s ability to qualify for an FHA loan, says Jennifer Hughes Hernandez, a senior loan officer with Texas-based Legacy Mutual Mortgage.

She's seen cases where the borrowers were teachers whose student debt would be canceled through the government's public service loan forgiveness program after 10 years. But they still could not qualify for an FHA mortgage.

“There are people I have to tell, ‘No, you cannot buy a house.' And they’re like, 'Wait a minute, I’m a teacher and they’re going to forgive (my student loan) in 10 years. Are you telling me I can’t qualify?' And I'm like, 'Yes, that’s what I'm telling you,'" Hernandez tells MoneyWise.

She says conventional mortgages generally have stricter requirements overall, but are a lot more lenient when it comes to student loan debt.

Even so, a borrower must have a pretty good credit score to qualify for a conventional loan — considerably higher than what the FHA requires. If your credit needs work, you might turn to a service that will help you build your credit to a higher score.

Steps to qualify for an FHA loan with student debt

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Let's say an FHA mortgage sounds like a good choice for you, but you're afraid you won't qualify because of your student debt. Here are a few steps to improve your eligibility.

You could explore refinancing your student loan debt into a new private loan with a lower interest rate. Student loan rates from private lenders have hit all-time lows, so moving your debt to a cheaper loan could help you pay off your balance faster and get you into a house.

If you’ve been paying attention to the news lately, you’ll know that President Joe Biden has been considering canceling at least $10,000 of student loan debt for every borrower. But note that his forgiveness — if it ever comes — will cover debt from federal student loans, not private ones.

If other types of debt are weighing you down, moving your balances into a lower-cost debt consolidation loan could be a good option for improving your financial stability and paying a lot less in interest.

Also, look for other ways to cut expenses and potentially save a bit more toward the down payment on a house. When your car insurance comes up for renewal, use a website that makes it easy to compare policies and make sure you're paying the lowest price.

You might also make a little extra for your down payment by investing in the soaring stock market — even if you don't have much cash. A popular app lets you grow a diversified portfolio using little more than "spare change" from your day-to-day purchases.

About the Author

Nancy Sarnoff

Nancy Sarnoff

Freelance Contributor

Nancy Sarnoff is a freelance contributor with MoneyWise. Previously, she covered commercial and residential real estate for the Houston Chronicle where she also hosted Looped In, a podcast about the region’s growth, development and economy. Her work has been recognized by the National Association of Real Estate Editors and the Society of American Business Editors and Writers.

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