Student debt can put a house out of reach

Heads up for millennials and first-time home shoppers carrying student debt: New rules could make it tougher to qualify for a low down payment Federal Housing Administration (FHA) mortgage. New rules on down payment gifts could complicate things for you as well.

The net effect of the changes, say mortgage lenders and analysts, will be to make FHA loans, which traditionally have been the go-to financing source for young, first-time and moderate-income purchasers, less attractive.

Here’s a quick overview of who will take the brunt of the new restrictions:

At the end of last year, young households and others had an estimated $1.2 trillion in outstanding student loan debt with an average balance close to $27,000, according to research by the Federal Reserve Bank of New York. Delinquency rates on those loans are significant: 17 percent of borrowers are delinquent or in default and another 20 percent are current on payments but have experienced delinquencies in the past.

Student loan payment obligations get rolled into the crucial debt-to-income (DTI) ratios lenders use to judge whether a borrower has the ability to repay a mortgage. Too high a ratio of total household monthly debt payments compared with income — typically somewhere in the 43 percent to 45 percent range — means the applicant is carrying too much debt and is more likely to default on the mortgage. Such applicants typically have a tougher time getting approved than people with lower DTIs.

Until Sept. 14, when the revised policy took effect, FHA treated applicants with student loan debt generously on DTI calculations: If an applicant had been granted a temporary deferment from making monthly payments by his or her student loan servicer for at least 12 months, the agency instructed loan officers to ignore the debt for DTI qualifying purposes.

Under the new rule, the agency will require that 2 percent of the outstanding student loan balance be counted in calculating the DTI, according to an explanation FHA sent to Congress. If you have a non-deferred payment plan, the actual monthly payment will be counted toward your household debt. So if you have a deferred student debt balance of $20,000, FHA will now impute a 2 percent ($400 a month) repayment obligation in calculating your DTI. That’s tougher than even giant investors Fannie Mae and Freddie Mac now require — 1 percent.

Why the increased restrictions, especially given FHA’s historic role as the home buying helper for the underserved? Brian Sullivan, an FHA spokesman, told me this: “Deferred student debt is debt all the same and really must be counted when determining a borrower’s ability to sustain both student debt payments and a mortgage over the long haul.” The agency’s primary goal, he added, is to put first-time homebuyers “on a path of sustainable homeownership rather than being placed into a financial situation they can no longer afford once their student debt deferment expires.”

What’s the likely impact on millennial shoppers who already are buying fewer homes than predecessor generations at the same age, in part because of heavy student debt burdens? Multiple lenders I spoke with said it’s certain to pose yet another hurdle for many applicants, and will be a deal-killer for others.

“I think the student loan being counted will be a big deal and knock a lot of loans out from qualifying” or force applicants “to buy less house” with a smaller mortgage, said Steve Stamets, a loan officer with Apex Home Loans in Rockville, Md.

In addition to the student debt changes, FHA tightened rules on the gifts that many first-time buyers receive from parents and other family members to help swing the transaction. In the past, a gift letter and a canceled check from the donor were acceptable to document the transfer of funds, but now you’re going to need to get a formal statement of the donor’s bank account — plus sourcing of any recent large deposits — to qualify. Lenders such as Stamets say this “will be a new headache” because some gift-givers don’t want to reveal what they’ve got in the bank.

FHA still remains an excellent mortgage source for anyone with less than perfect credit. And most of its rules are more lenient and forgiving for borrowers than competitors. But if you’ve got a lot of deferred student debt, you may need to take a new look at whether you’ll qualify.