Delinquent student debt could soon create a new hurdle to homeownership in an already challenging marketplace.
On May 5, the Department of Education will resume collections on defaulted federal student loans, according to its April 21 announcement. The pandemic stalled collections haven’t happened in March 2020.
More than 5 million borrowers have not made a monthly student loan payment in over 360 days and sit in default. Four million borrowers are in late-stage delinquency (91-180 days). As a result, there could be almost 10 million borrowers in default, which is almost 25% of the federal student loan portfolio, according to the announcement.
Let’s dissect some of the important questions for those defaulted and delinquent borrowers who might be on the road to homeownership or mortgage refinancing.
How do student loan defaults and late-stage delinquencies affect credit scores?
Accounts delinquent 60 days or more are a big negative for credit scores, according to John Ulzheimer, a nationally recognized credit expert and president of the Ulzheimer Group. Delinquent is the same as a defaulted loan. The balance (dollar amount owed) is irrelevant.
“For a borrower with a high credit score, it can drop the score well over 100 points. Many borrowers have several student loans, not just one,” said Ulzheimer. “Ninety percent of student loans have a co-signer.” That means everyone’s credit gets affected.
To illustrate, let’s say you have a 719 middle FICO credit score. You are shopping for a home loan. You haven’t made a payment on your monthly student loan payment in at least 180 days. Your credit score sinks to 619.
Mortgage giants Fannie Mae and Freddie Mac require at least a 620 middle FICO credit score. So, no conventional loan for you.
One alternative is FHA financing, as it will go down to 580 with 3.5% down. A 500 credit score requires a minimum 10% down. FHA financing also comes with mandatory and very expensive mortgage insurance, regardless of your down payment.
In another scenario, your credit score gets crushed but it’s still over 620. Conventional loan pricing works from a matrix of loan-to-value and lowest middle FICO score of all borrowers. You would likely see a substantially higher cost for a low FICO score.
How do you get on the good side of the Department of Education in respect to your delinquent or defaulted student loan?
You can seek a settlement with a DOE servicer, but the settlement will be 100% of what is owed, according to Joshua Cohen, a consumer law attorney.
“You can do a consolidation loan refinance of multiple student loans (into one),” Cohen said.
A rehabilitation program by the DOE’s Default Resolution group offers delinquent borrowers an option to clear their default by making nine payments to catch up and then resume their original student loan payment plan. The nine payments are determined by the applicant’s income, he said.
The DOE website to address student loan issues is studentaid.gov.
“You can also get rid of it (student loan debt) in bankruptcy, if it’s an undue hardship,” Cohen told me.
As concerns a mortgage application, none of these solutions erase the previously defaulted or delinquent bad mark on a credit report.
If you file chapter 7 bankruptcy, you will need to wait at least a couple of years from the discharge date until you can get any type of lower-cost mortgage credit.
Some exotic lenders (so-called non-QM lenders) may write a mortgage one day after a Chapter 7 discharge.
A key reason to address a defaulted or delinquent student loan debt is to avoid wage garnishment. “When wage garnishment starts you are stuck,” Cohen said. “You are issued a 30-day letter and then garnished. There is no lawsuit (required).”
“The administrative wage garnishment is 15% of your after-tax income,” said Lisa Espada, another consumer attorney. “They can also offset the debt by taking your tax return refund or taking 15% of your Social Security benefits.”
Obviously, if 15% of your net income is garnished, it’s going to make it a lot more difficult for you to afford a mortgage, much less qualify for a mortgage.
Here are some student debt facts from the Educational Data Initiative:
—The outstanding federal student loan balance is $1.693 trillion with 42.7 million student borrowers carrying federal loan debt
—The average federal student loan balance is $38,375
—72% of student debt holders who do not own homes say they believe student loan debt will delay homeownership
—The average student borrower takes 20 years to pay off their student loan debt
—47% of student debt holders said their loans prevented them from making a down payment on a home
Pay your student loan debt as best you can. Contact the DOE if you are delinquent or in default to see if you can qualify for the Rehabilitation option. Do not bury your head in the sand. This challenge will only get worse if you ignore what you owe regardless of whether you have your eyes set on homeownership or not.
Esquire Espada recommends an excellent website for those with student loan questions is studentloanborrowerassistance.org.
Freddie Mac rate news
The 30-year fixed rate averaged 6.81%, 2 basis points lower than last week. The 15-year fixed rate averaged 5.94%, 9 basis points lower than last week.
The Mortgage Bankers Association reported a 12.7% mortgage application decrease compared with one week ago.
Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $806,500 loan, last year’s payment was $195 more than this week’s payment of $5,263.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.875%, a 15-year conventional at 5.625%, a 30-year conventional at 6.5%, a 15-year conventional high balance at5.99% ($806,501 to $1,209,750 in LA and OC and $806,501 to $1,077,550 in San Diego), a 30-year high balance conventional at 6.75% and a jumbo 30-year fixed at 6.75%.
Eye-catcher loan program of the week: A 40-year fixed rate mortgage, interest-only for the first 10 years at 6.875% with 1 point cost.
Jeff Lazerson, president of Mortgage Grader, can be reached at 949-322-8640 or jlazerson@mortgagegrader.com.
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