There's good news for would-be homebuyers with federal student loans who are enrolled in government repayment programs for struggling borrowers.
The nation's largest purchaser and guarantor of mortgages, Fannie Mae, now says that it won't hold it against borrowers if the monthly payments they're making on their student loans aren't even covering the interest they owe.
When the monthly payments on your student loans are too small to cover the interest that's owed, you've got a loan that's "negatively amortizing" -- the outstanding balance is getting bigger, rather than smaller, each month.
That's not an unusual situation for borrowers who have enrolled in income-driven repayment (IDR) plans like PAYE and REPAYE, which let them devote as little as 10% or 15% of their monthly discretionary income to repaying their federal student loan debt.
These programs can be great for struggling borrowers, because they can significantly reduce your monthly payment. According to the latest figures from the Department of Education, about 6.5 million Americans are currently paying back $333 billion in educational debt in an IDR plan.
The trade off of these plans is that by stretching payments out over a longer period of time -- up to 20 or 25 years -- your overall repayment costs may increase dramatically. This is particularly true for borrowers who don't end up qualifying for loan forgiveness.
As I detailed in a recent Forbes column, it used to be that if the monthly payments borrowers were making in an IDR plan weren't big enough to fully amortize their loan, Fannie Mae would not accept that payment for purposes of calculating your debt-to-income (DTI) ratio.
That's important because the monthly payments you make on everything from student loans to credit cards and car payments can push your DTI past the maximum limits set by Fannie Mae, Freddie Mac and FHA.
Until now, if your monthly student loan payment wasn't big enough to pay off your loan in 25 years, Fannie Mae expected lenders to either calculate a monthly payment that would fully amortize your loans, or use an amount equal to 1 percent of the outstanding balance.
If you were paying off $49,000 in student loans at 6.8 percent interest in an IDR plan like REPAYE, your monthly payments with an adjusted gross income of $50,000 would start out at $266 a month.
The monthly payment required to fully amortize that loan based on the 25-year term specified by Fannie Mae would be $340. Alternately, plugging 1 percent of the loan balance into the DTI formula would be $490 a month.
The new guidelines let mortgage lenders use the monthly student loan payment information provided on the borrower's credit report to calculate DTI. So if you're enrolled in an IDR plan, lenders can use the monthly payment associated with the plan to calculate your DTI -- even if that payment does not cover all of the interest you owed that month.
Another new twist that can work in your favor: If somebody else is paying down your student loans (or if you've got credit cards or auto loans being repaid by a benefactor) Fannie Mae will let mortgage lenders ignore those debts when calculating your DTI.
"We understand the significant role that a monthly student loan payment plays in a potential home buyer's consideration to take on a mortgage, and we want to be a part of the solution," said Fannie Mae's Jonathan Lawless in a press release.
As many borrowers learned during the housing downturn, just because you can qualify to buy a house doesn't mean that you should.
Borrowers who take advantage of programs that let them make little or no down payment have little equity in their homes, which makes it more likely that they'll end up in foreclosure if they can't make their mortgage payments.
But student loan debt shouldn't automatically disqualify would-be homebuyers from realizing their dreams. If you're one of the estimated 1 million student loan borrowers who are in a strong enough financial position to buy a home this year, check out my previous post on how to make the most of the spring homebuying season.