Housing groups seek change to FHA loan restriction on student debt

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A broad range of industry organizations is calling for the Federal Housing Administration to lower a particularly high bar set for mortgage applicants who have income-based student loans.

The Mortgage Bankers Association and 18 other groups argue that the current requirements unfairly disqualify borrowers who have education loan debt by using “a formulaic calculation in lieu of the actual monthly obligation that appears on the credit report,” which then results in an artificially inflated debt-to-income ratio, they wrote in a letter to the FHA.

Many agencies used to have mortgage underwriting calculations for these loans that were more in line with the FHA’s measure, which has been in effect for several years. But over time, most of them — like the U.S. Department of Agriculture or Freddie Mac — have revised their calculations to help lower this barrier to entry for first-time homebuyers.

“I think that as millennials have moved into the homebuying market it’s an issue that has become more of a focus,” said Julienne Joseph, the MBA’s assistant director of government housing programs.

“I also think it’s kind of a perfect storm for them right now with the tightening of the credit box,” she added.

More than half of senior loan officers at banks reported either a severe or moderate contraction in government-loan underwriting standards during the second quarter. The sudden contraction in underwriting reported in several loan categories within the Federal Reserve’s SLO survey is generally the most extreme seen since the Great Recession, according to a recent report by Moody’s Investors Service.

While the last underwriting contraction of this magnitude was driven excessively loose standards, lenders were more cautious prior to the recent economic downturn. That may make it possible for lenders and government-related agencies to be more flexible now.

“We don’t have a housing bubble and homeowners are in better shape than the average population,” said Warren Kornfeld, a senior vice president in Moody’s financial institutions group.

Roughly 15% of consumers with federal student loans are making income-based repayments, according to Moody’s, so flexibility in mortgage underwriting could help a significant number of borrowers access home loans at the historically low rates available today.

The majority of all Bachelor’s degrees recipients have graduated with some level of student debt in recent years, according to a 2019 College Board report. Blacks, who represent the largest minority group among millennials, are the most likely to graduate with student debt.

“This disproportionately affects Black people because we often have to take more student loans compared to our white counterparts, and it’s an issue for the broader market too,” said Donnell Williams, president of the National Association of Real Estate Brokers, one of the other groups that signed the letter to the FHA.

NAREB, the MBA and other groups such as the American Bankers Association, the Asian Real Estate Association of America and the National Association of Realtors all would like to see the income-based student loan calculation changed because they say in most cases the requirements far exceed the payments borrowers would make, and could be lowered without putting consumers in danger of qualifying for mortgages they couldn’t repay.

“Instead of looking at what the actual amortizing payment would be, the FHA presumes 1% of the outstanding balance as the monthly payment,” said Joseph. “The reason why we’re writing the letter is to ask FHA to reconsider that position.”

The letter proposes two alternatives that would allow the FHA to roll back its 1% rule and bring in more in line with other government-related agencies’ practices.

One alternative would use the borrower’s actual monthly payment in debt-to-income calculations that are considered in FHA underwriting. The other alternative would be to reduce the percentage of the outstanding loan amount to 0.5%, in line with a change the USDA made for rural housing loans it insures last year.

The 0.5% calculation generally would approximate a value somewhere between the actual income-based repayment amount and what a fully amortized payment would be, Joseph said.

The Department of Housing and Urban Development confirmed receipt of the coalition’s letter, which was sent to Federal Housing Commissioner Dana Wade.

“We appreciate the input from the coalition, and are currently reviewing the letter,” HUD said in an emailed statement.

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