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For the most up-to-date information on federal student loan forgiveness, go to the U.S. Department of Education's Federal Student Aid website.
Under the administration's plan, you may be eligible for $20,000 in debt relief if you are a Pell Grant recipient and $10,000 if you did not receive a Pell Grant. Forgiveness is available to borrowers who make less than $125,000 and couples who make less than $250,000.
Along with student loan forgiveness, the president proposes a new income-driven repayment plan with several new benefits, such as cutting the current minimum payments in half, from 10% of your discretionary income to no more than 5% for undergraduate loans.
President Biden's forgiveness plan could free up money you can use toward achieving other financial milestones, such as owning a home. Here's how the president's student loan forgiveness program could help you reach homeownership sooner than you might think.
It Could Lower Your Debt-to-Income Ratio
When you receive debt forgiveness, your student loan balance drops. This reduces your total outstanding debt and, consequently, your debt-to-income ratio (DTI). DTI is the amount of your monthly income dedicated to paying debts, including credit card minimum payments and student loans.
You can calculate your DTI by dividing the total of your monthly debt obligations by your monthly gross income, and multiplying the result by 100. Generally, the lower your DTI, the better your odds of qualifying for a mortgage.
Lenders look at your DTI as an indicator of your financial ability to make monthly mortgage payments. Not surprisingly, lenders prefer borrowers with lower DTI because it indicates less risk of defaulting on a loan.
It Could Increase Your Credit Score
Student loan debt relief could make it easier for you to improve your credit score and meet the minimum credit score requirement for a mortgage loan. That's because the loan forgiveness could create extra room in your budget and make it easier to take credit-building action, such as:
- Building your payment history: Your payment history is the most important factor of your credit score, accounting for 35% of your FICO® Score☉ , which is the credit score used by 90% of top lenders. If debt forgiveness lowers your monthly payments, it will be easier to avoid missed payments and build a positive credit history.
- Paying down debt: With lower payments, or even zero payments, you'll have extra money to pay off other debts, such as high-interest credit cards. Lowering your credit utilization ratio―the amount of available revolving credit you're using―could positively affect your credit score since credit utilization makes up a 30% chunk of your credit score.
Bear in mind, closing your student loan accounts could make your credit mix less diverse and negatively impact your credit momentarily. Credit scoring models consider your credit mix, which makes up 10% of your credit score, to see how well you manage different types of credit, including mortgages, car loans, credit cards and student loans.
Fortunately, any dips to your credit should be minor, and your credit score should recover in a matter of months, all other things being equal.
It Could Make Saving for a Down Payment Easier
When the repayment pause lifts in January, your monthly student loan payments will take income that otherwise could go toward paying down other debts or saving. If you receive debt forgiveness that wipes out your student debt balance, you can redirect liberated repayment money toward a savings account and build a down payment on a house.
Coming up with a 20% down payment on a home with a conventional loan is challenging, but doing so delivers benefits, such as eliminating the need for private mortgage insurance (PMI). Since PMI can cost you about 2% of your loan balance each year, eliminating it from your loan costs could represent significant savings over the life of your loan.
How to Buy a House With Student Loan Debt
How should you approach buying a home if the student loan relief you receive isn't enough to erase your student loans? Fortunately, student loan debt doesn't disqualify you from buying a home. You can still prepare your finances and credit to qualify for a mortgage. Consider these tips to help you qualify for a mortgage, even if you're a first-time homebuyer with student loans.
- Improve your credit. While some lenders and programs work with homebuyers with bad credit, most conventional loan lenders require a minimum credit score of 620. However, a score of 660 or higher will open you up to more lenders and options. If your credit is below average, take steps to improve your credit score before applying.
- Lower your debt-to-income ratio. Even if you have to trim your budget or volunteer for overtime at work, try to pay down debt to lower your DTI. As a general rule, your DTI should be less than 43%, but many lenders look for ratios below 36%.
- Apply for preapproval. Getting a preapproval letter can let you know what loan amount, down payment and loan costs you can expect. Also, when you are ready to put an offer on a home, buyers are more likely to take your offer seriously if you already have a loan preapproval.
- Investigate assistance programs. You may find relief from programs offered by your state, local government or charity organizations. For example, Maryland SmartBuy 3.0 helps eligible borrowers buy a home while paying off up to $50,000 in student loan debt. The U.S. Department of Housing and Urban Development (HUD) provides a database of homebuyer programs in your state that may offer down payment and closing cost assistance.
- Consider government-backed loan programs. FHA, USDA and VA loans may help you qualify for a home loan with a low or no down payment and less stringent credit score requirements. For example, you may qualify for an FHA loan with a 500 to 579 credit score and a 10% down payment. Similarly, you may be eligible with a credit score as low as 580 and a 3.5% down payment.
- Look into other loan forgiveness programs. Investigate other long-standing student loan forgiveness programs you may qualify for, such as Public Service Loan Forgiveness (PSLF) for public sector workers and teacher loan forgiveness for those working in schools serving low-income students. Any loan forgiveness you receive can lower your debt-to-income ratio and give you more discretionary money to save for a home.
- Apply for income-driven repayment (IDR) programs. The Department of Education offers numerous IDR plans to make your student loan debt easier to manage with monthly payments based on your income and family size. President Biden's student loan forgiveness plan includes a new IDR plan that allows for payments as low as 5% of your discretionary income and debt forgiveness after 10 years of payments if your debt is less than $12,000.
The Bottom Line
Even if the amount of student loan forgiveness you receive doesn't totally eliminate your student loans, it's still likely to make a big dent in your remaining loans. As you approach buying a home, think about the ways forgiveness may cause you to restrategize your approach. You may, for instance, be able to shift more money toward paying down your credit cards or building your down payment.
Before you start the homebuying process, consider checking your credit report and credit score for free with Experian to see the status of your credit profile. Monitoring your credit can also help you understand how changes to your credit report affect your credit score.