If you’re looking to buy a home, an FHA mortgage could help make that happen. FHA-insured loans have easier-to-meet credit requirements, lower down payments, and reduced closing costs.
But if you have student loan debt, you might have some extra considerations when applying for an FHA mortgage. Here’s an overview of the FHA mortgage guidelines as they relate to student loans.
FHA Mortgages Explained
FHA mortgages are home loans offered by approved lenders and insured by the Federal Housing Administration (FHA). This insurance offsets lenders’ risk, allowing them to lend to borrowers who may not be considered ideal home candidates because of lower income or credit scores.
As a result, FHA loans can offer better interest rates to borrowers than conventional mortgages, with more flexible requirements for a down payment and credit history. Generally with FHA loans, you will need at least a 3.5% down payment and a credit score of 580 or higher for maximum financing.
To qualify for an FHA mortgage, your debt-to-income (DTI) ratio, which compares monthly debt payments with monthly income, needs to be 43% or less (including the potential mortgage payment).
That’s where student loans come in—your student loans will be considered in calculating your DTI for an FHA loan, even if you’re not currently making payments on them. In fact, student loans may be treated somewhat differently than your other debt payments.
FHA loans are offered by private lenders, which may have their own credit, income, DTI, and down-payment requirements. For that reason, it’s important to shop around to find mortgage lenders willing to work with you, and to find a low-cost loan that meets your needs.
The 1% Rule for Student Loan Debt
All student loans with outstanding balances must be included when calculating your DTI ratio, per FHA rules. For borrowers with a fixed monthly student loan payment based on amortization, the regular payment amount is used. (Most lenders will know this amount because it’s included on your credit report.)
But it’s not always that simple. Student loan borrowers in deferment or forbearance (including the automatic forbearance offered starting in 2020 because of the pandemic) have no required payments, and others, on income-driven repayment (IDR) plans, for example, could have very low monthly payments. These borrowers will have an amount larger than what they’re currently paying figured into their DTI.
This is because of something called the 1% rule. It says lenders cannot use a student loan payment lower than 1% of the outstanding balance to calculate DTI.
Specifically, lenders must use the greater of 1% of the outstanding student loan balance or the minimum payment listed on the credit report. They may use a student loan payment if it is less than that only if it is an amortization-based payment (such as a 20-year loan) and with documentation of the original student loan agreement.
Here’s an example of how this rule might be applied on a $35,000 balance (5% interest rate and $35,000 annual income), depending on payment plan or status:
|Payment Plan/Status||Monthly Required Payment||1% Rule Amount||Payment as Calculated for an FHA Loan|
|Private student loan with a 20-year term||$231||$350||$231|
|Income-based repayment (with $35,000 income)||$141||$350||$350|
|Deferment or forbearance||$0||$350||$350|
Other FHA Student Loan Considerations
Beyond the calculation of your DTI, student loans are part of your credit history, which lenders will review in the loan application process. Lenders favor a history of on-time monthly payments, so late payments, delinquencies, or a student loan default can make it harder to qualify for an FHA loan.
If making student loan payments each month limits your ability to save for a down payment and other homebuying costs that come with a traditional mortgage, an FHA loan can help because it requires a lower down payment and closing costs (usually 2% to 4% of the purchase price, versus 3% to 6% for most conventional mortgages available).
FHA Alternatives for Those With Student Loan Debt
Having a high student loan balance in comparison to your income could be an obstacle to qualifying for an FHA loan. Here are some other options and steps to consider.
Calculate your DTI, taking the 1% rule above into consideration. If it’s too high, you can improve it by increasing your income, paying down student loan or other debt, or doing both.
You can also look into a conventional mortgage, especially if you have a high credit score. A Freddie Mac loan, for instance, uses 0.5% instead of 1% to calculate loan payments that are suspended because they are in forbearance or deferred.
Buying a home is an exciting step. Taking stock of your student loan burden and weighing your options can help you decide if an FHA loan is the right path to homeownership for you.
U.S. Department of Housing and Urban Development. "Handbook 4000.1, FHA Single Family Housing Policy Handbook." Page 161.
U.S. Department of Housing and Urban Development. "Handbook 4000.1, FHA Single Family Housing Policy Handbook." Page 162.
U.S. Department of Housing and Urban Development. "Section F. Borrower Qualifying Ratios." Page 4-F-4.
U.S. Department of Housing and Urban Development. "Handbook 4000.1, FHA Single Family Housing Policy Handbook," Page 198-199.
U.S. Department of Housing and Urban Development. "Handbook 4000.1, FHA Single Family Housing Policy Handbook." Page 198-199.
U.S. Department of Housing and Development. "Common Questions From First-Time Homebuyers."
Freddie Mac. "Monthly Debt Payment-to-Income Ratio."