Student loan forgiveness means financial change for millions of Americans. For some, it could be the difference between buying a home and seeing it outside.
President Joe Biden’s plan to forgive eligible borrowers up to $20,000 in student loan debt and shrink income-related repayment schedules will likely make it easier for many to qualify for a mortgage, experts say.
“It will make homeownership more accessible to more people because student loans have put a lot of people off homeownership,” says Stacie Rihl, a homebuying educator and real estate agent.
While this limited forgiveness doesn’t give every borrower a clean slate, it can significantly improve a prospective homebuyer’s debt-to-income ratio, although it could result in a temporary drop in credit scores for some.
So experts say forgiveness could change things when you apply for a mortgage.
What is your debt to income ratio?
The Debt to Income Ratio, or DTI, is a measure of how much of your income goes towards paying down your debt each month. Lenders don’t necessarily focus on your total debt, only what your monthly payment is. It’s calculated by dividing your total monthly debt payments — student loans, credit cards, car loans, etc. — by your gross monthly income. DTI requirements vary by loan type and lender.
How lenders calculate DTI has been complicated by the pause in student loan payments since the pandemic began. If you don’t pay your loans, lenders can include either 0.5% or 1% of your outstanding balance, Rihl says. “It can be a lot,” she says. “If you have $50,000 in student loans, that’s a big monthly payment for lenders to account for.”
How Forgiveness Affects Mortgage Applications
The big headline of the president’s August announcement was forgiveness — $10,000 for borrowers making less than $125,000 a year ($250,000 for couples) and $20,000 for those borrowers who are in the Borrowed money through the Pell Grant program for low-income students.
“The impact of the student loan forgiveness program is that for borrowers whose student loan debt was part of their outstanding debt, the amount of their outstanding debt is reduced,” said Rob Cook, vice president of marketing, digital, and analytics for Discover home loans.
If you have less outstanding debt, a mortgage lender is more likely to expect you to be able to repay the loan they are about to offer you and, as a result, you will be more likely to approve or approve a larger loan. That could be especially helpful for borrowers who are already “on the brink of creditworthiness,” says Cook. If your credit score and income are in good shape but that high student loan balance is holding you back, forgiveness might push you over the edge.
Right now, “someone could have a great job and have a down payment, but if their debt-to-income ratio is too high, the numbers are the numbers, they can’t be approved,” says Rihl.
Close the gap
Black homebuyers are denied a mortgage to buy a home twice as high as the total population in the nation’s 50 largest metro areas, according to a report by LendingTree, which analyzed data from the Home Mortgage Disclosure Act of 2020. A likely contributor is the legacy of discriminatory policies like redlining — in which borrowers in predominantly black neighborhoods were denied home loans — and discrimination by lenders toward black borrowers. If you’re being denied a mortgage, research different lenders and perhaps consider other types of credit, such as FHA or VA loans. If you feel discriminated against, report it to your Attorney General or the US Department of Housing and Urban Development.
Monthly student loan payments can also be reduced
The President also announced a plan to create a new income-driven repayment program that would allow borrowers to cap their monthly payments to 5% of their monthly discretionary income.
That could further improve borrower terms, Rihl says, by making monthly payments even smaller and reducing your DTI, even if the forgiveness doesn’t significantly impact your overall loan balance.
“If you’re just using 5% depending on how much they’re making, that can really reduce debt payments,” says Rihl. “I think it will make home ownership easier for a lot of people.”
Consider an income-based repayment plan that caps your monthly payment. This could significantly improve your debt-to-income ratio and increase your chances of getting a mortgage deal.
Forgiveness could hurt your credit, but don’t worry too much
If your loan is forgiven in full, your credit score could drop, experts say. For many, student loans are the oldest accounts on their credit report, and losing them from your report will take a toll on your credit history. That’s just one factor that goes into determining your creditworthiness, and it’s not the most important. Any drop would be temporary and not having to pay around $10,000 is worth it.
Full forgiveness can also affect your credit mix if it’s the only installment loan you have — as opposed to a line of credit like a credit card — because rating agencies also check if you have a variety of different types of credit.
You’ll have to wait to see the benefit
These student loans have not yet been issued. There are a few steps you need to follow to take advantage of this, including applying by the end of the year.
But even after approval, it will likely take some time for your financial records to reflect the change. That means if you’re looking to buy a home, you may not see the benefits of forgiveness until next year.
“People may have to wait to get approved and then they have to work with their lender and the credit bureau,” says Cook. “It will take time for the amount of debt to be accurately reflected on their credit report.”