Is student loan forbearance a negative for home loan?

becky205 · Joined: 13 Jun 2008 Posts: 4

Hello,

I’m a newbie here at the forum. I’ve done a search on this topic, but didn’t find any situations quite like mine, so I hope you don’t mind my question.

Long story short:
In 2004, I began having some major medical issues and was unable to work for a 1.5 years. Because of the loss of my income, my husband and I declared Chapter 7 bankruptcy in 11/04 and were discharged in 2/05. When we declared BK, our student loans ($26,000 and $39,000) automatically went into forbearance, and we’ve kept them in forbearance since then so we could save some money in case a rainy day hit once again.

Fast forward 3+ years:
We are now back on our feet again financially. We’re hoping to buy our first home later this year. We assumed that we needed to put our student loans back into repayment so that potential lenders would see that we are paying our loans again. However, when I called Direct Loans (U.S. Dept. of Education) to do so, I was counseled against it. This obviously came as a big surprise! Basically, I was put on the phone with a veteran student loan officer, and he told me that banks typically do not consider it negative when student loans are in forbearance. He was most concerned about the interest charges that had accumulated in the past 3+ years, and the fact that they would be capitalized the minute we went back in repayment. In other words, we’ll be paying interest on interest. He strongly recommended that we both stay in forbearance for as long as it takes to pay off the accumulated interest in order to prevent it from being capitalized. (He also actually recommended that I apply for an economic hardship deferment based on my low income and back date it 12-18 months in an attempt to override the current forbearance and shave off a few thousand in previous interest charges—but that’s another topic altogether.)

Our dilemma:
Our biggest concern is that we already have a big strike against us with the bankruptcy, so we don’t want to do anything else to jeopardize our changes at getting a home loan. However, if banks truly don’t care if our student loans are in forbearance, it would save us a lot of money if we stay in forbearance while paying off the accumulated interest as the loan officer suggested. Obviously, we’ll be discussing this with potential banks, but I’d really appreciate all of your opinions on this!

Here’s a bit more information about our situation in case it influences your answer:
*Our credit scores range from 672 to 743 (my scores are 681-683-719 and my husband’s are 672-735-743), which is pretty good considering the BK.
* My husband’s parents will be gifting us the money for our down payment ($40K = 23%), so we’re hoping this will help our chances at purchasing a home in the $160K-$170K range (loan amount of $120K-$130K).
* My husband just started a new job in March after having been laid off last October (along with 300 other people). He makes $49K per year gross.
* I’ve been self-employed since July 2006. My 2006 tax return shows a slight loss because of start-up costs; my 2007 tax return shows a profit of $7,000 after deductions; I am currently pulling in around $1,500-$2,000 before taxes each month. We’re planning to submit information on my income for the loan, but we don’t expect it to have much impact.
* Debts: No credit card debt; 2 car payments (each $250), but one will be paid off in less than 9 months. Student loans will total around $500/month when we go into repayment.
* We will only consider a 30-year fixed mortgage; no ARMs. Willing to pay 1-3 points to get interest rate in the 6% range.

I look forward to hearing your opinions! Thanks in advance.

Best regards,

Becky

m2c · Joined: 03 Aug 2005 Posts: 767

You should sit down face-to-face with a LO since your situation is tricky. Fannie goes on discharge date for the bankruptcy and so “by the books” you’re out of luck and I suspect Fannie would not be up for a loan-level variance given the state of the market. Freddie (I think, don’t know for sure) goes from the filing date so maybe there’s an opening there.

Doing the loan just in your husband’s name might be more beneficial. Under FICO “hits” you’re an albatross FICO-wise and add a one-half discount point hit while not bringing much to the table income wise. Any debt that is solely yours would not be considered in a husband-only transaction and get your total debt ratio back to more comfortable levels.

The mortgage market has been trashed this week so I don’t know how realistic you rate/point combination is. CPI was slightly above expectations; core on target. Work week and compensation might control but I haven’t looked yet.

If you walked through my door AND I believed in you, I’d probably suggest a 7-year balloon (30-year amortization) to allow you to transition into a conforming loan down the line. Many brokers do this type of loan with their own cash so the loan doesn’t have to follow Fannie or Freddie standards. Big downside is that you must refinance in at least another seven years – another set of closing costs and you don’t know what rates will be then.

Remember – renting has advantages.

becky205 · Joined: 13 Jun 2008 Posts: 4

Thanks for your quick reply! A few questions for you...

How long do Fannie and Freddie require us to be out of bankruptcy? At this point, it's been nearly 3.5 years since our discharge date.

We're considering applying for a loan under only my husband's name for the reasons you mentioned. This may sound silly, but I assume that he would be the only one on the title if we did this, correct? I'd really like to be on the title, but not if it prevents us from qualifying for a loan altogether.

Given our circumstances, I thought we would at least qualify for an FHA loan if nothing else. You don't think there's a good chance of that?

We've been renting since we got married 9 years ago, so we're very aware of the advantages of renting! :D

Thanks again!

Becky

m2c · Joined: 03 Aug 2005 Posts: 767

Shortest answer first – yes, both of you can be on the title even if only his name is on the mortgage note.

Now the verbose answer on bankruptcy. Here’s Fannie on Chapter 7:
The lender should keep in mind that we have specific eligibility criteria for reestablishing credit that must be satisfied before approving a new mortgage to a borrower who had a prior bankruptcy or foreclosure in his or her credit history. Generally, we require a minimum elapsed time of four years between the discharge of a bankruptcy or the completion of a foreclosure and the date of the mortgage application. However, when a bankruptcy is filed under Chapter 13 (or under Chapter 7, if the bankruptcy was the result of documented extenuating circumstances), we require only a two-year elapsed time for reestablishing credit. See Section 803.02 for more guidance on reestablishing credit after the discharge of a prior bankruptcy or the completion of a prior foreclosure.
The reference is X 302.10 so you can read the ins and outs on efanniemae.com. Fannie has recently come down with both feet on FORECLOSURES in Annc 08-08 and release notes to DU version 7.0. The latter provides a hopeful sentence on bankruptcy in the generic terms and states the absolute prohibition is two years from filing. Huh, where did that come from? Either way you’re close or past the time when you can hop back in the water but in your case there are other issues.

Student loans and even forbearance and discussed in X, 702 which even goes into the “less than 11 months” bit the “other” happy talk mentioned in response to your inquiry there. Pay attention to the caveat of “significantly affects”. If both cars loans and student loans are joint or in your husband’s name, I suspect an underwriter will have some qualms about tossing the debts out. Again you can read for yourself on efanniemae but here is part of the passage:

Installment debt. Generally, all installment debt that is not secured by a financial asset—including student loans, automobile loans, and home equity loans—should be considered as part of the borrower’s recurring monthly debt obligations only if there are more than ten monthly payments remaining to be paid on the account. However, an installment debt with ten or fewer monthly payments remaining also should be considered as a recurring monthly debt obligation if it significantly affects the borrower’s ability to meet his or her credit obligations.
Deferred installment debt—such as student loans and loans in forbearance—must also be included as part of the borrower’s recurring monthly debt obligations. If the borrower’s credit report does not indicate the monthly payment that will be payable at the end of the deferment period, the lender should request a copy of the borrower’s payment letter or forbearance agreement so that it can determine what payment amount to use in calculating the borrower’s total monthly obligations.
FHA is “easier” on Chapter 7s and is very specific:
Bankruptcy. A Chapter 7 bankruptcy (liquidation) does not disqualify a borrower from obtaining an FHA-insured mortgage if at least two years have elapsed since the date of the discharge of the bankruptcy. Additionally, the borrower must have reestablished good credit or chosen not to incur new credit obligations. The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs. An elapsed period of less than two years, but not less than 12 months, may be acceptable if the borrower can show that the bankruptcy was caused by extenuating circumstances beyond his or her control and has since exhibited a documented ability to manage his or her financial affairs in a responsible manner. Additionally, the lender must document that the borrower's current situation indicates that the events that led to the bankruptcy are not likely to recur.
But with FHA the student loans might cause an issue with the CAIVRS check – have the LO run this initially before starting the FHA process. At your husband’s FICO, you’d be paying 1.25% net (1.5% upfront MIP for FHA less adverse market with Fannie) plus effectively an extra 0.5% in “rate) for the monthly MIP until the mortgage (exclusive of UFMIP) falls below 78% of initial house value.
Bottom line: Getting some background via the Internet is great but you need to start working with a LO; strike that, reputable LO. My guess is that an underwriter is going to be interested in your savings (cash management) over and above the gift bearing in mind whatever you have accumulated I think has been accomplished while the student loan payments were “on hold”. Six-month job gap combined with four months on current job will be a concern plus if all debt is included, total debt ratio will be “up there”. FICO score and LTV are encouraging factors and I’d sprinkle in a factoid about your income as a possible compensating factor. Since you’re not on the note, this is a little illogical but I’d try. Get a firm, “no holds barred” pre-approval before submitting an offer on a new home.

becky205 · Joined: 13 Jun 2008 Posts: 4

Thanks for posting all the excerpts from the Fannie Mae website. I'll go have a look at the site soon.

So it sounds like we'd have to wait until February 2009 to apply for a Fannie Mae loan (4 years after our discharge), unless they see our BK as being caused by extenuating circumstances. Do sudden health problems and subsequent loss of income usually meet this requirement?

I'm glad you mentioned the CAIVRS check in regard to the FHA loan. I didn't know about that. I don't think we're technically considered "delinquent" or in "default" since we've never been late on a payment, but we'll have to find out if the forbearances will throw up red flags during the check. Good to know!

Regarding the MIP on the FHA loan: We'll have a 23% down payment going in, but I've read that we'll have to pay MIP anyway since they go by 78% or 5 years, whichever is longer. Still need to clarify this though.

Although my husband was unemployed for 5 months, he was steadily employed for 5 years right after graduating from college. There are no other gaps in his employment history since then. Does the 5 years of steady employment count for anything?

My student loan is not in my husband's name, so if we apply for the mortgage only under his name, this wouldn't be included in the DTI ratio. That would help! My car is in both of our names, but if the loan officer felt that my car loan would "significantly affect" our ability to meet our obligations even though we have less than 9 months left, we could easily pay it off as we only have $2,400 left to go.

We haven't taken on any additional debt since the BK. We now have $20,000 in savings, albeit while our student loans have been in forbearance. Because of my health situation and inability to work outside the home, we felt it was very important to build up a large emergency fund in case my husband was laid off, which he eventually was. This time we landed on our feet though! Live and learn.

We're definitely planning to talk with a loan officer soon, but we want to be sure we're well informed before making any moves we'll regret later. We’ll definitely be going for a full-blown pre-approval before doing anything.

I really appreciate your insight on this. Thanks again!

Becky

m2c · Joined: 03 Aug 2005 Posts: 767

With that amount of additional savings, the car debt will most likely be excluded and ratios on your husband look good. You may get some wiggle room in DU but I tend to favor “manual” – brings the personality of the applicant(s) more into the picture and every once in a while you get a weird condition. DU is a “roach motel” and once you run, there’s no going back to manual. A lot is going to depend how your husband’s student loan shows on credit report – an amount in delinquent payment column could be an issue.

You could probably go FHA right now. Here’s what I don’t like about FHA with this much down and good FICO score. Say the base loan amount is $120,400. You’d pay round $2,800 in monthly MIP with no time value of money kicked in. On top of that you’d pay (cash or financed) upfront MIP of over $1,500. That ain’t chicken feed! If you do want to rush and go FHA, a little gamesmanship comes into play and remember the date 7/14/08. If the case number is ordered before that date you get his with 1.50% ($1,806.00 in $120,400 base loan example); on or after that date and he drops to 1.25%. Might as well save the 300 odd dollars. Any good LO will manipulate this time but it doesn’t hurt to remind him/her.

Now to the current and perhaps near-term future of FHA. Wholesalers are overwhelmed with increase in FHA volume. Why you ask and why aren’t you affected? With Fannie, borrowers with FICOs south of 720 start paying on the 30-year terms. For example, at 20% down with a 660 FICO, the whack is 1.25 discount points. Shave a single point off that FICO and the hit goes to 1.75! End result is that “turn times” are long and/or wholesalers are “pricing up” to slow volume down. Neither is good for you. Hence many brokers are moving into position to do their own underwriting – not always possible. If you do decide to go FHA, ask which office the underwriter sits in. If the broker isn’t underwriting themselves, I’d be cautious in the current environment. You can cover by extending “lock period” but drops between months are increase in the MBS market and this has become increasing costly.

becky205 · Joined: 13 Jun 2008 Posts: 4

Thanks for all the tips. If the car debt isn't excluded, we'll just pay it off, so that shouldn't be an issue. Also, neither of our student loans shows up as delinquent since we've never been late on a payment. They show up on our credit reports as "Open/never late. Deferred, payment date unknown." We'll see what CAIVRS has to say.

I've heard that FHA has been getting slammed since the sub-prime lenders have vanished. I'm *really* hoping we can go conventional if at all possible, especially given our down money. We're going to start talking to lenders soon, so we shall see...

Thanks again!

Becky