Urban Wire Student Debt Relief Could Help Some Borrowers Access Homeownership
Jason Cohn, Caitlin Young
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Young family outside a house.

For some borrowers, student loan debt can be a hindrance to homeownership. Having outsize loan balances can raise borrowers’ debt-to-income (DTI) ratios—which most lenders consider to be an important indicator of borrower creditworthiness in their underwriting decisions—and prevent them from saving money. And for borrowers who’ve defaulted on their student loans, the hit to their credit score could make them ineligible for a mortgage.

The Biden administration recently announced its proposal for student debt relief, which includes $10,000 of loan forgiveness for most borrowers with up to $20,000 of forgiveness for Pell grant recipients, a more generous income-driven repayment (IDR) plan, and an extension of the payment pause through the end of the year. The administration also released the details of its Fresh Start initiative, which will allow defaulted borrowers to return to a current status when student loan payments resume.

These proposed policy changes could speed up the path to homeownership for some student loan borrowers—particularly borrowers of color—by lowering their DTI ratios, allowing them to save more for down payments, and improving their credit histories.

Reduced debt-to-income ratios

Currently, the median outstanding student loan debt is about $20,000, meaning many borrowers will have their entire balances forgiven. For a borrower repaying a $20,000 loan who has their entire balance forgiven, monthly payments would drop from more than $200 to $0. But even among those with significant outstanding student debt, expected monthly payments will decline. As a result, many households with student debt will see their DTI ratios fall.

DTIs are calculated as significant monthly expenses, including any student loan payments, divided by gross monthly income. The significant reduction in or elimination of monthly student loan expenses could move households on the margins of homeownership readiness into a DTI ratio at or below 45 percent, the standard limit used by Fannie Mae in its underwriting practices.

The new IDR proposal would have implications for DTI ratios as well. When implemented, the plan would substantially reduce monthly payments for student loan borrowers. Last year, the Federal Housing Administration updated its guidance for calculating student loan monthly payments when a borrower is using IDR so these calculations would be more reflective of the borrower’s actual monthly payment. As a result, the reduction in monthly payments under the new IDR proposal will also affect DTI ratios and make it easier for some borrowers to qualify for a mortgage.

A recent bachelor’s degree graduate, for example, could make payments as low as $20 under the new IDR proposal, down from $115 under the most generous current IDR plan. Even for borrowers who would already be eligible for a mortgage, a reduction in debt of this size could allow them to purchase a home of nearly $20,000 higher value.

Increased savings

Student loan borrowers have already benefited from more than two years of paused federal loan payments, but now many of these borrowers will be able to continue to save what they would have otherwise spent on student loan payments once the payment pause ends. The additional savings could allow borrowers to accumulate a down payment more quickly, speeding up their path to homeownership or allowing them to buy a higher-priced home.

The new IDR proposal’s reduction in monthly payments could also help borrowers save even if their entire balance isn’t wiped out. Although they’ll still be making payments, many borrowers will pay a much smaller share of their discretionary income than they were before the COVID-19 pandemic.

Improved credit histories

When student loan payments resume in January, borrowers in default will have the opportunity to move to a current repayment status with the negative effects of defaulting removed from their credit histories. Student loan default and the delinquencies leading up to a default can cause a drop in a borrower’s credit score of up to 90 points. Having these delinquencies and default erased from their credit histories could help some student loan borrowers’ credit scores rebound enough to reach a score that would make them eligible for a mortgage.

A student loan borrower who has been in default on their loan but has no other blemish on their credit report could see their credit score move from near-prime to prime, or even from subprime to prime. Borrowers of color will most likely see the greatest benefits from this credit score boost, as they are more likely to default on their student loans than white borrowers in part because of discriminatory systemic barriers to building generational wealth.

Student debt relief could help narrow the racial homeownership gap

With Biden’s proposal allocating an extra $10,000 in student loan forgiveness for Pell grant recipients, the student debt relief plan will target benefits so borrowers of color receive a larger reduction in their balances on average. Among Black student loan borrowers who first enrolled in the 2011–12 academic year, 88 percent received a Pell grant, compared with 60 percent of white borrowers. Student loan borrowers who identify as American Indian or Alaska Native, Asian, Hispanic or Latino, or Native Hawaiian/Pacific Islander are also more likely to have received a Pell grant than white borrowers.

This extra loan forgiveness could further improve DTI ratios for borrowers of color, meaning they may be able to commit more to a monthly mortgage payment or save more quickly for a down payment. Overall, the additional benefit for Pell grant recipients could lead to a small improvement in racial equity in homeownership.

Most student loan borrowers will need to fill out an application to receive loan forgiveness and to participate in the new IDR plan. Evidence suggests this administrative burden will lead to fewer borrowers receiving debt relief, which could hinder its impact on homeownership access and equity. But real estate professionals, housing counselors, and mortgage loan originators could maximize the effects of student debt relief on homeownership by making borrowers aware of how to access these benefits and how the benefits could help them apply for a mortgage. Ensuring student loan forgiveness and IDR are widely accessed by borrowers can help these policy changes increase equity in homeownership.

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Research Areas Housing finance
Tags Higher education Homeownership Racial homeownership gap
Policy Centers Center on Education Data and Policy
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