Those with student debt get mortgage aid
Fannie Mae last week announced three small steps it is taking to make it easier for people with education loans to get or refinance a home mortgage.
The government mortgage giant, which guaranteed onethird of home loans in the first quarter, is responding to claims — coming mostly from the real estate and mortgage industries — that student debt is preventing Millennials from buying a house.
“We saw a big run-up in student loan originations around the time of the housing collapse. The reason for the run-up could have been that parents couldn’t refinance their home” to put their kids through college, said Rohit Chopra, a senior fellow with the Consumer Federation of America.
The new initiatives could prop up loan volumes when they could use a lift. Whether they make sense for borrowers “really depends” on their individual circumstances, Chopra said.
The main program Fannie announced last week will make it a tad cheaper to refinance a mortgage and pull cash out to pay off an education loan.
Fannie charges an additional risk fee that adds about 0.25 percent to the interest rate when people refinance a
mortgage and borrow more than their outstanding balance. This is known as a cash-out refi. The fee does not apply when borrowers refinance their current balance just to get a different rate or term and don’t take cash out.
Fannie will now waive that fee when borrowers do a cash-out refi and use virtually all the cash to pay off at least one education loan. (A small amount of the cash can pay closing costs.) They must be paying off their own student or parent loan or one they cosigned.
Fannie piloted this program with San Francisco lender SoFi in November. Neither would say how many borrowers have used it, although inquiries “were off the charts,” said Jonathan Lawless, a Fannie vice president.
For borrowers, swapping a federal education loan for mortgage debt is not even worth considering unless you can save at least one or two percentage points, and even then it might not be a good idea, said Mark Kantrowitz, publisher of Cappex.com, a college and scholarship search site.
Federal education loans, such as Stafford and Plus loans, have benefits you lose if you refinance them into a mortgage. These benefits include deferment or forbearance, which lets you temporarily make zero or reduced payments in certain cases; income-driven repayment plans, where your monthly payment is based on your income; and loan forgiveness and cancellation programs.
“If times get tough, borrowers could dial down their student loan payments. Once they do this debt swap, they will have a little less flexibility,” Chopra said. “They are also putting their home at risk.”
Private education loans have fewer benefits and generally higher interest rates than federal loans, so swapping them carries less risk.
Borrowers should also consider the tax implications.
On federal and private education loans, you can deduct up to $2,500 per year in interest, even if you don’t itemize deductions. To take this deduction, you must pay the interest and be the borrower or cosigner on the loan.
This deduction phases out to zero if your modified adjusted gross income is more than $80,000 (single) or $165,000 (married filing jointly). You cannot take this deduction if your parent pays off your loan, if you can be claimed as a dependent or if you file your taxes as married filing separately.
On mortgage debt, you also can deduct interest, but only if you itemize deductions, and only up to a certain limit.
Borrowers generally can deduct interest on up to $1 million in debt used to buy or improve a home and up to $100,000 in home-equity debt, which is debt not used to buy or improve a home. If you are subject to alternative minimum tax, you cannot deduct home-equity interest.
If you do a cash-out refi to pay off $120,000 on student loans, you could only deduct interest on $100,000 of that debt, assuming you have no other homeequity debt and are not in AMT.
Another thing to consider: If you are paying off student debt over a standard 10-year repayment term, and you convert that to 30-year mortgage debt, you could wind up paying more interest over the life of the loan, unless you make extra principal payments.
With interest rates on the rise, “Fannie Mae and lenders have a vested interest” in promoting cash-out refis, said Guy Cecala, publisher of Inside Mortgage Finance. “In a rising rate environment, nobody’s going to do rate-reduction refis.” Cash-out refis “will keep volume up.”
The two other new rules Fannie announced last week apply to borrowers who are buying or refinancing a home.
If you apply for a mortgage and can prove that someone else — such as a parent or employer — paid your nonmortgage-debt for the past 12 months, Fannie will no longer count that debt in your debt-toincome ratio for qualifying for the loan. This applies to all non-mortgage debt including student, credit card and auto loans.
Excess debt to income “is the main reason loans don’t get through our (underwriting) engine,” Lawless said.
The third new rule applies to borrowers in income-based repayment plans. These plans let people with a lot of student debt relative to their income pay less than the full amount on their federal student loan. Borrowers must re-qualify each year and after a certain number of years, remaining debt could be forgiven.
“Historically when you got underwritten (for a mortgage), we have been afraid to use that lower payment. We would override that payment and put in a much higher payment,” Lawless said. “Now we are going to use the student-loan payment that shows up on the borrower’s credit report.” The lower payment will reduce the borrower’s debt-to-income ratio, making it easier to qualify for a mortgage.
Taylor Gosney, director of product development with RPM Mortgage, had a loan application last week from a doctor who had $383,000 in student loans, but was paying only $147 a month. As a resident, the doctor’s income was low enough to qualify for incomebased repayment.
Under Fannie’s old rules, RPM would have had to calculate a much higher payment for the doctor. “Now they say, if it’s on your credit report, and it says $147, we will use that.”
Whether people who can’t pay the full amount on their student loans should be getting a government-backed mortgage is another question. If you’re a resident whose income will surge in a few years, maybe so. But if your career trajectory is uncertain, probably not.
“If you are in incomebased repayment, the last thing you need is more debt,” Kantrowitz said.