Sam Silverstein is a former writer-producer for the National Association of REALTORS® based in Washington, D.C.
Schooled in Debt
Rising home values enable homeowners to roll student loans into their mortgages. But the strategy has risks.
May - June
Consumers saddled with student loan debt often have to delay financial goals, like buying a home. But for those who want the benefits of ownership before their student debt is paid off, Fannie Mae has options that can make it easier to qualify and handle the monthly payments.
While you can’t give specific financial advice to clients, you can help them understand the benefits and risks. “We can be advocates for our clients and potentially direct them to the right place,” says Mary Shanley Aloisio, a sales associate with Dream Town Realty in Chicago.
Relief from the secondary market giant can come in one of three ways. First, buyers whose student loans have income-driven repayment terms (meaning they pay less when they’re making below a certain income) can qualify based on what they’re actually paying at the time of application, as shown on their credit report. So if they’re paying $0 each month based on their income, the debt won’t be counted in calculating their debt-to-income ratio. Second, lenders will exclude debt that’s being paid by someone else (like a parent) as long as the borrower can provide 12 months of documentation and there’s no history of delinquency. Finally, those who’ve already purchased a home may be able to improve their monthly cash flow through a cash-out refinance that’s used to pay off the student debt (no partial paydowns are allowed). The refinancing option is even available to parents who’ve co-signed student loans for their children. Freddie Mac also has special options for student loan borrowers. Buyers should talk to their lender to determine availability of, and their eligibility for, these products.
Aly, a 29-year-old Chicago public high school teacher (who asked that her last name not be published), graduated from the University of Illinois at Chicago in 2012 with $50,000 in student loan debt. She and her wife saved money, compared with renting, when they bought a home in 2016 for $147,000. But a combination of rising property taxes and rising home values prompted the couple to look into refinancing. With a cash-out refi, they were able to pay off Aly’s remaining $18,000 in student debt.
Tapping home equity to retire other kinds of debt can make financial sense by giving people more money to spend on other expenses or invest in tax-advantaged retirement plans, says John Kambs, a senior loan officer with the Kambs Jennings Group of Chicago, part of Compass Mortgage. Looking at home buying through this lens underscores the value of owning instead of renting and is a powerful motivator for people trying to decide whether to buy, says Kambs, who arranged the couple’s new loan.
But this tactic has significant risks, warns Robin Howarth, a senior researcher at the Center for Responsible Lending in Durham, N.C. For one thing, moving student loan debt into a different type of loan, such as a mortgage, means giving up the protections that generally come with borrowing money to attend school, such as being able to defer repayment during a financial emergency or to attend graduate school, she says. “It’s hard to look into the future and know if you might need to avail yourself of those protections.”
There’s also the risk that home values may decline and that the borrowers won’t be able to meet their obligations, Howarth adds. “Everyone underestimates the possibility of something going wrong,” particularly if they haven’t gone through the kinds of setbacks that befell many home owners during the Great Recession, says Howarth.
Aly was aware of the protections that come with student loans and even investigated debt-forgiveness programs designed for teachers, but she was put off by the bureaucracy required to take advantage of those options. “It would have been hours of paperwork and hunting people down,” she says. “Refinancing seemed much simpler.”
Bonus: The couple knocked about $400 per month off what they were spending on their mortgage and student loan payments.
Updated: February 27, 2020