According to a Urban Institute study.
Having inflated loan balances increases borrowers’ debt-to-income ratios (DTIs), which lenders consider an important indicator of borrower creditworthiness in their underwriting decisions. It also prevents them from saving money for a down payment.
For borrowers who have not repaid their student loans, the damage to their credit score could make them ineligible for a mortgage.
The Biden administration recently announced its student debt relief proposal, including $10,000 in loan forgiveness for most borrowers and up to $20,000 in loan forgiveness for Pell scholarship receipts. This also includes a more generous income-based reimbursement (IDR) plan and an extension of the payment pause until the end of the year.
The administration also released details of its Fresh Start initiative, which would allow defaulting borrowers to return to a current status when student loan repayments resume.
The Urban Institute urges the administration to make these policy changes and accelerate the path to homeownership for student borrowers — especially borrowers of color — by lowering DTI ratios and improving their credit history.
The median outstanding student debt is around $20,000, so many borrowers would see their entire balance canceled once the policy takes effect. For these borrowers, monthly payments would drop from $200 to $0. Even for those with significant debt, the expected monthly payments would decrease.
DTIs are calculated as major monthly expenses, including student loan repayments, divided by gross monthly income. A significant reduction or elimination of monthly student loan expenses could shift households on the fringes of homeownership readiness to a DTI ratio at or below 45%, the standard limit used by Fannie Mae in its underwriting practices.
Last year, the Federal Housing Administration (FHA) updated its guidelines for calculating monthly student loan payments when a borrower uses IDR, so that these calculations are more accurate of borrowers’ actual monthly payment. It would also affect DTI ratios, making it easier for some borrowers to qualify for a mortgage.
Increase in savings
Student loan borrowers have already enjoyed more than two years of suspended federal loan payments, but now many of those borrowers could continue to save what they would otherwise have spent on student loan payments once the payment pause ends. . The extra savings could help more borrowers save for a down payment and buy more expensive homes.
Improved credit history
When student loan repayments resume in January, defaulting borrowers will have the option to transition to current repayment status, with the negative effects of default removed from their credit history.
Defaulting on a student loan and defaults leading to default can cause a borrower’s credit score to drop by as much as 90 points. Removing these defaults and defaults from their credit history could help student borrowers’ credit scores rebound enough to reach a score that would make them eligible for a mortgage.
Borrowers of color would most likely see the greatest benefits from increased credit ratings, as they are more likely to default on their student loans than white borrowers, in part due to discriminatory systemic barriers to building credit. generational wealth.
Narrow Racial Homeownership Gap
Biden’s proposal would allocate an additional $10,000 in student loan forgiveness to Pell grant recipients. Among black student borrowers who first enrolled in the 2011-12 academic year, 88% received a Pell grant, compared to 60% of white borrowers. Student borrowers who identify as Native American or Alaska Native, Asian, Hispanic or Latino, or Native Hawaiian/Pacific Islander are also more likely to have received a Pell grant than white borrowers.
The additional loan forgiveness would further improve DTI ratios for borrowers of color, meaning they might be able to commit more to a monthly mortgage payment or save up for a down payment faster. The added benefit for Pell Grant recipients would mean a slight improvement in racial equity in home ownership.
In order to receive loan forgiveness, student borrowers will need to complete an application, and evidence suggests that this administrative burden will lead to fewer borrowers receiving debt relief. But real estate professionals, housing advisers and mortgage loan officers could explain to their clients how to access these benefits and how these benefits could help them apply for a mortgage. Overall, these policy changes can increase homeownership equity.