Financial advisors whose clients have student loans, co-signed student loans or want to help a borrower repay their student debt should take note of new policies from Fannie Mae, which also make it easier for those borrowers to qualify for a mortgage.
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Under the expanded Innovative Solutions for Borrowers with Student Loan Debt, Fannie Mae, the biggest buyer of home mortgages from lenders, has eliminated the 0.25% standard fee for cash-out refinancings. With such refinancings, a homeowner can borrow more than the amount of the original loan, taking the difference in cash, which can then be used to help pay off the student loan.
Anyone can take advantage of the new policies if their new loan doesn't exceed Fannie Mae's cap of $424,000 ($636,150 in Alaska and Hawaii) and if they have enough housing equity, says Jonathan Lawless, vice president of customer solutions at Fannie Mae.
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That includes the 8.5 million homeowners who currently owe student debt either on their own behalf or on behalf of their children, as co-signers of loans or borrowers of Parent Plus loans, and potentially even more. Currently 44 million people owe $1.4 trillion in student debt in the U.S. All mortgage lenders who sell their loans to Fannie Mae, can offer the cheaper cash-out refis, which essentially expands a pilot program that begin in November with nonbank lender SoFi.
“This is a good option for borrowers with high income and stable jobs who are sitting on plenty of home equity,” says Rohit Chopra, senior fellow at the Consumer Federation of America. "There is a major chunk of outstanding Direct and [Federal Family Education Loans] with interest rates at 6.8% (Stafford loans), 7.9% (Direct Plus), and 8.5% (FFEL Plus) and many private loans also carried double-digit interest rates." They can refinance at rates below 4%.
But "for those who don’t have a secure job, it comes with some risk,” says Chopra.
The primary risk is if a borrower loses his or her job or suffers from some other financial setback. “They will be giving up their rights to income-driven repayment options on federal student loans, which cap those payments to roughly 10% of their income," says Chopra. "They also won’t be able to adjust their student loan payment down to zero using a federal student loan deferment. Like many financial innovations, there can be gains for many borrowers, though they need to be careful before signing on the dotted line.”
There could also be tax implications. Borrowers who earn less than $80,000 and don’t itemize can deduct student loan interest payments, but taxpayers who do itemize can deduct the mortgage interest payments.
There is more than just the opportunity for cheaper refis under Fannie Mae's expanded program for student loan borrowers. Fannie Mae is also modifying mortgage eligibility qualifications for student loan borrowers who want to purchase a home, which can help lenders and the housing market.
The program will exclude student loans as well as auto loans and credit card debt from the debt-to-income ratio formula used to qualify for a mortgage when that debt is paid by someone else. That had not been the case until now. Even if that debt was paid by someone other than the person applying for the mortgage it was included in the calculations used to qualify for a mortgage.
Now those borrowers will be “more likely to qualify for a loan,” says Lawless.
Also included in the previous calculations lenders used for mortgage applications were student loan payment levels based on what borrowers theoretically would be charged to pay off their loans over a specified period of time, not what many enrolled in income-driven repayment plans were actually paying. Now Fannie Mae will allow lenders to include those lower student loan payments in their calculations.
“We understand the significant role that a monthly student loan payment plays in a potential homebuyer’s consideration to take on a mortgage, and we want to be part of the solution,” Johnathan Lawless, vice president of customer solutions at Fannie Mae, said in a statement. “These new policies provide three flexible payment solutions to future and current homeowners and, in turn, allow lenders to serve more borrowers.”
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Student loan debt has been blamed for the lower rate of homeownership among millennials compared with earlier generations. A recent report by economists at the Federal Reserve Bank of New York found that even though college graduates have a higher homeownership rate than non-graduates, graduates with outstanding student loans have a lower rate of homeownership than graduates with no debt.
The researchers found that every 10% increase in student loan debt caused a 1 to 2 percentage point drop in the homeownership rate for student loan borrowers during the first five years after leaving school. Even in their early 30s, college graduates with student debt had a lower rate of homeownership than those with less or no debt, according to the researchers.
“We’ve spent a lot of time talking to lenders and realtors and student loans are on their minds,” says Lawless. “The housing industry is terrified of a generation not becoming homeowners … Student debt is an investment in people and their future potential. They’re a long-term good credit risk. Precluding them from owning a home is a mistake.”
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