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Automatic federal student loan forbearance was supposed to provide relief, but for some home buyers it's become an unexpected obstacle

  • People with high student loan balances could have a hard time qualifying for a mortgage if their federal student loans are in forbearance.
  • When mortgage lenders don't see a monthly payment, they estimate that the payment each month is equal to 1% of the loan's balance.
  • For people with high student loan balances, that 1% may be much more than they actually owe, and skew their debt-to-income ratio.
  • This could especially affect people with income-based repayment plans, whose monthly payments are actually much lower.
  • Learn more about getting or refinancing a student loan with CommonBond

Now that mortgage interest rates have hit historic lows during the coronavirus pandemic, many previously hesitant millennial homebuyers are re-considering and looking to buy . But college grads with significant federal student loan debt could face an unexpected snag.

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All federal student loans are in automatic forbearance until September 30, 2020, as outlined by the CARES Act. All federal student loan borrowers (excluding borrowers with Parent PLUS loans or federal Perkins loans) have had automatic billing stopped, and interest rates suspended until the forbearance period ends.

Travis Hornsby, a student loan adviser and expert at Student Loan Planner , told Business Insider that he'd spoken with multiple borrowers who found the way their forbearance is being reported is making it difficult to get approved for a mortgage.

It all comes down to debt-to-income ratio.

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In the process of underwriting borrowers for mortgages, banks calculate debt-to-income ratios how much money you owe versus how much money you earn to determine a potential borrower's ability to repay a new loan. Lenders can see all monthly payments you make, including on your federal student loans.

Mike D'Ambrosio, the director of credit risk at online mortgage lender Better.com , told Business Insider that forbearance often interrupts the way banks calculate debt-to-income ratios. When banks collect information on your monthly debt payments, a loan in forbearance could lead the banks to calculate an estimated payment that may not be right.

"A student loan in a deferred or forbearance status may not report any monthly payment, because you may not be obligated to make one. It may just say zero," he said. "If that's the case and you're in that deferred or forbearance status, typically lenders use 1% of the outstanding loan balance as an estimated payment."

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Hornsby explains that for people with high student loan balances, or for those with income-driven repayment plans that adjust monthly payments according to what the borrower is able to pay, it's not uncommon for that 1% calculation to be much higher than their actual monthly payment.

About 6% of Americans owe more than $100,000 on their student loans, according to November 2019 data from the Brookings Institution . According to data from the Consumer Financial Protection Bureau , over 25% of all federal student loan borrowers were on an income-driven repayment plan in 2017.

As an example, Hornsby puts forward a hypothetical pharmacist, making $100,000 a year with $200,000 of student loan debt. Their debt-to-income ratio has to be below 40% to qualify for a mortgage, including their mortgage payment. If this pharmacist's federal loans are in forbearance, the bank may assume their payments are 1% of the outstanding balance a month: $2,000. This puts the pharmacist's debt-to-income ratio at about 24%, before factoring in a potential mortgage.

However, what's not clear to the bank is that this pharmacist is on an income-driven repayment plan and actually only owes $500 a month only a quarter of what the bank has estimated. "If their real payment is $500 per month, but the banks say it's $2,000 because of the 1% rule, that pharmacist is not going to qualify for a house at all," Hornsby said. "That pharmacist could 100% make that mortgage payment, absent any pandemic forbearance."

Even without income-driven repayment plans, this could affect people who have high debt balances and low incomes. Healthcare workers could also be disproportionately affected by this, Hornsby says in that industry, high student loan balances tend to overshadow high salaries .

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Calling your lender to remove the forbearance from your account and paying on your loans again could be an option to remedy this situation. But, in income-driven repayment plans where the remaining balance is forgiven after the loan term (typically 20 to 25 years), it's not worth it the months between when the federal forbearance started in March 2020 and when it ends in September will automatically count towards forgiveness whether you pay or not.

A better option, Hornsby suggests, is to talk with several different mortgage lenders to find one who is willing to accommodate this situation.

D'Ambrosio suggests submitting documentation on your loans to prospective lenders, so they can re-calculate your debt-to-income ratio. "Get the loan documentation so your lender can see what a fully amortizing payment would be," he said. Finding the paperwork that documents your student loan's interest rate, balance, and loan term would allow the lender to correctly calculate what you owe monthly.

"You may have to do a little bit of more digging in your file cabinet to get the paperwork, but it may result in a better outcome," D'Ambrosio said.

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