The Frugal Creditnista

A Crash Course on Student Loans and How it Affects Your Credit

I get tons of questions on student loan debt and how they impact other areas of our finances, especially when it comes to home buying and credit.  Let’s look at some specifics:

Student Loan Interest

Did you realize that student loan interest rates are set by Congress and not your lender?

This is why your interest and income-based repayment might not align. Your interest payment is going to remain the same, regardless of whether your repayment is income-based or not. So even if your principal payment goes up or down, whatever you’re paying on interest won’t change.

This is an important point to factor into your finances when you’re trying to build credit, pay down your debt, or make other major financial moves like buying a home.

The Impact on Credit

If you have student loans and have tried to purchase a home, you probably left a lot of skid marks in the road during the process, right? Student loans have their share of surprises when it comes to credit.

One of the major things lenders look at is your debt-to-income ratio. This is a figure pulled from your gross monthly income divided by your fixed monthly expenses, such as mortgage, insurance, car payments, etc.

When including your student loans in this equation, lenders generally consider 1% of whatever you owe. For example, if you have $125,000 in student loans, they factor in $1,250.

If your debt-to-income ratio exceeds whatever bar they’ve put into place, you’re automatically denied. That’s the number one reason why most people are denied a mortgage – not because of credit, but because their debt-to-income ratio is too high.

Knowing this now, it’s important you demonstrate the most affordable payment possible (zero is ideal!).

There IS a way to use your income-based payment as opposed to the 1%.  It doesn’t work with all loan types (as described below), so keep that in mind as well.
Here’s how it works:  If a lower payment is stated on your credit report, you can use it in your debt-to-income ratio in lieu of the 1% – even if it’s $0. If the $0 payment terms expire in a few months, then as long as you have documentation proving that it will be renewed for another year at $0, you can still use that $0; debt-to-income problem resolved!!!

Not All Lenders Are Created Equal

Keep in mind that if one lender says no, you always have other options. Not all lenders have the same requirements when it comes to debt-to-income ratios. FHA loans are the most forgiving, touting 56% of your total income can go toward debt, including the mortgage. Conventional loans are less resilient, allowing about 50% of your income to go towards debt, while VA loans may only allow for 46% to cover debts.

Another thing to consider is how the lender looks at your student loan debt. FHA isn’t interested in your income-based repayment – they’re looking at your actual debt, so a $0 payment won’t fly here. Conventional lenders WILL take an income-based payment option, so a $0 payment would be acceptable.

Here’s an example, Fannie Mae’s underwriting playbook mentions that lenders must use the amount indicated on the credit report. However, if no amount is specified or if the amount is $0, they can either use student loan documentation to verify the amount, use the 1% rule, or opt for a fully amortizing payment using the documented loan repayment terms.

The important part to remember is that it literally pays to investigate your options, especially when weighing things like credit score, debt-to-income ratio, whether you need to consolidate your debt, and other criteria that lenders may look for. It’s not always the same, and knowing which lender will most favorably view your unique situation can make all the difference in acquiring your home.

What to Do Next

If Student Loans are holding you back, make sure you take my Fire Your Student Loan Debts inside of my Credit on Fire Academy!    

If you are seeking homeownership and wondering where to start, my Claim My Keys Masterclass is for you!  Guess where you can enroll in that course???? Inside of my Credit on Fire Academy!  

Hope this helps!

~ Netiva

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