According to research by the Federal Bank Reserve of New York, student debt is one of the main reasons for the drop in homeownership in the U.S. amongst millennials. As of Q2 in 2017, student loan debt is $1.45 trillion compared to $549 billion in Q2 of 2007. In fact, student debt has tripled in little over 11 years.
As well as the initial property expenditure, homebuying also leads to additional purchases such as furniture, repairs and gardening equipment. The study’s researchers believe that student debt accounts for up to 35% of the decline in homeownership amongst Americans aged 28-30 since 2007. The study went on to suggest that if student debt had remained at 2001 levels, an additional 360,000 young Americans would have owned a home by 2015.
New Hope on the Horizon
As of May 2017, major rule changes by mortgage investor Fannie Mae could completely alter the game. The purpose of the changes is to make it easier for first-time homebuyers to purchase a property or for people to use cash-out refinancing to pay off their student debt. It is a necessary and important change and should help at least a proportion of the 43 million Americans that are carrying student loan debt.
The Effect of Student Loan Debt on the Economy
As practically every entrepreneur and financial advisor will tell you, owning your home is the #1 way to build wealth. Historically, the American economy has relied on household spending for up to 70% of its growth. However, if Millennials are trapped by student debt, they have to cut their spending which doesn’t bode well for the economy.
Fannie Mae’s 3 Major Changes
Before we delve into the changes, please note that the new programs, along with ones that have been around for a few years, aren’t ideal for everyone. In some instances, the initiatives are designed for borrowers who are just about able to afford a new home. If you’re in that situation, think long and hard before proceeding.
1 – Lower ‘Cash Out’ Refinancing Costs
This could be the right program if you’re one of the estimated 8.5 million American homeowners with student debt. Fannie Mae will get rid of its normal costs associated with ‘cash out’ refinancing as long as you use the withdrawn money to pay off your student debts. It is a potentially good solution for parents that have co-signed their children’s loans and parents who are part of the ‘parent plus’ programs designed to pay off their children’s student debts.
2 – Change in Debt-to-Income (DTI) Ratio Calculations #1
This change could help the 5 million borrowers who utilize federal reduced-payment plans on their student loans. If you are among this number, your actual monthly payment will count toward your DTI ratio calculations. Previously, lenders had to factor in 1% of your student loan balance as your monthly payment on the loan, even if you were paying much less. As a consequence, the DTI ratios of many borrowers ended up beyond the underwriting limits of lenders.
Let’s say you originally had to pay $400 a month, but your payment was reduced to $100 via an income-based repayment plan. Under the new rule, only the $100 is added to your repayments for DTI.
3 – DTI Ratio Assistance #2
Originally, non-mortgage debts paid by someone else (your parents paying your credit card bill for example) were included in your DTI calculation. Under the new rule, these debts are eliminated from the calculation as long as you make payments consistently for 12 months. As a result, young buyers will no longer be punished when their parents provide them with financial assistance.
Real Help Just When It Is Needed
The new changes should make an enormous difference to the purchasing intentions of younger would-be homeowners. The vice president of one lender admitted that it was difficult for people to be approved for mortgages when carrying student debts over $50,000 or more under the old rules.
A loan officer in California’s Orange County provided a real-world example of how the new changes will help. He said that a prospective borrower made an application and had student loan debts of $100,000 which was used to pay for her children’s education. While she was only paying $100 a month at that time, the mandatory 1% calculation rule meant her debt was listed at $1,000 a month. As a result, she was ineligible for the loan. Under the new rules, her debt is listed at $100 a month which means she will probably be approved.
Buyer Beware
Not everyone is as enthusiastic about the changes. One senior loan officer in Maryland is concerned about the size of the student loan debts. He points out that if borrowers have problems making full payments or paying down the loans, they could ultimately default. It is important to note that Fannie Mae has not changed its other underwriting criteria including its credit score requirement, which is criticised for being too strict.
If you’re looking to swap your student debt for mortgage debt, shopping around could save you thousands. Also, please note that if you have a federal student loan and pay off the debt with mortgage refinancing, you give up guaranteed government protection including the ability to pay off your debt according to your income and pausing payments during times of financial difficulty.
In addition, your home will become collateral for the debt and could be taken away if you default on the loan. One on hand, you could receive a better rate with a mortgage compared to your student loan rate. On the other hand, you lose the protections afforded to you by the federal student loan program. In this scenario, an alternative is to look for a private lender that refinances student loans.
We are genuinely interested to see how and even if, Fannie Mae’s changes will alter the property buying landscape.