On April 25th Fannie Mae released 3 new policies that will affect student loan borrowers. The CSLA BOS was pleased to see that Fannie Mae recognizes the negative impact student debt has on the finances of many who have student loans. The new changes will provide important relief to student loan borrowers. Here we have clarified the changes and identified important points financial advisors should make note of when helping their clients.
Student Loan Cash Out Refinance: Borrowers who have available equity in their home can now refinance and take out cash to pay their student loans and have the funds directly transferred to their loan servicer. With home prices at or near all-time highs, and interest rates at or below 4%, it is estimated that approximately 8 million households could potentially benefit. In general, student loans have higher interest rates than today’s mortgage rates making the use of home equity a potentially good strategy. The new Fannie Mae policy provides an alternative way for student loan repayment and will simplify the process by the direct transfer of funds to the loan servicer.
From an advisory perspective, there are numerous considerations for your clients when you discuss cash out refinances.
Advisors need to carefully review the terms of the student loans to be paid off in the transaction.
- Debt forgiveness is allowable in the case of death or permanent disability of the borrower.
- Using a cash out refinance from home equity can provide interest savings but borrowers will be giving up potentially valuable protections afforded only with Federal student loans.
- Federal loans offer consumer protections in the case of financial hardship allowing the postponement or reduction of payments.
- In addition, reduced equity in their home could place the borrower at an increased risk of being “underwater” on their mortgage if home prices decline.
- Another benefit of this approach is that the interest paid on the refinance has larger tax benefits than interest on student loans. Up to $2,500 of interest on student debt is deductible but it phases out for single borrowers earning more than $65,000 ($130,000 if married filing joint) and is not deductible if the borrower earns more than $80,000 ($160,000 if married filing joint).
- Through a cash out refinance, student loan borrowers can reduce their payment and increase their tax deduction. For borrowers with higher balances seeking to pay off larger student loan balances, keep in mind that the ability to deduct the interest from a home equity line of credit (HELOC) or a cash out refinance is limited to $100,000 ($50,000 if married filing separate) borrowed.
Changes Impacting the Mortgage Qualification Process
Currently for conventional loans sold to Fannie Mae, the maximum debt, including the applied for mortgage cannot exceed 36% (45% if they meet credit score and reserve requirements) of the borrower’s stable income. The change in policy will allow borrowers to qualify for larger monthly payments and higher purchase prices by taking into account their actual loan payments.
Debt Paid by Others: The new rule excludes debts paid by others such as cases where employers pay a portion of the employee’s loan payment. If the borrower can demonstrate that s/he is not responsible for debts shown on their credit report, those debts are not include in the calculations use for determining the debt to income ratio.
Student Debt Calculations: As noted earlier, prior to this policy change borrowers who had student loan payments that were on extended repayment plans (>10 years), the debt payment was assumed to be 1% of the total debt.
This change in policy by Fannie Mae brings their policies in line with the conforming loans purchased by Freddie Mac. Freddie Mac has already allowed borrowers to qualify for home mortgages using their reported payment on the credit report as opposed to the 1% figure previously used by Fannie Mae.
By allowing more lenders to have access to the new policy put in place by Fannie Mae, borrowers of student loans looking to qualify for a mortgage using their actual payment will now have more lenders to choose from as not all lenders were able to conform to Freddie Mac’s standards.
A warning: One note to keep in mind, assuming the Fannie Mae policy conforms to Freddie Mac’s, borrowers in forbearance, deferment, or and income driven repayment plan where their payment is calculated to be $0 per month will still be subject to the 1% rule as the credit report will not report a payment due at all.
In summary Fannie Mae has made some policy changes that can be favorable for student loan borrowers. For the most part the changes are not significant as two of the three changes were already options for borrowers but the new policies will streamline the mortgage process for student loan borrowers.