New changes announced by Fannie Mae targeting current and future homeowners with student debt create both opportunities and risks for consumers, especially for those who use mortgage credit to pay off a student loan.
“Swapping student debt for mortgage debt can free up cash in your family budget, but it can also increase the risk of foreclosure when you run into trouble,” said Rohit Chopra, Senior Fellow at the Consumer Federation of America and former Assistant Director of the Consumer Financial Protection Bureau. “For borrowers with solid income and stable employment, refinancing can help reduce the burden of student debt. But for others, they might be signing away their student loan benefits when times get tough.”
As the largest source of mortgage credit in America, Fannie Mae’s announcement could have a significant effect on the mortgage market and student borrowers. More than 43 million Americans owe $1.4 trillion in outstanding student debt.
Fannie Mae updated its Selling Guide to permit originators that sell loans to the mortgage giant to offer a new refinance option for the purpose of paying off a student loan. Proceeds from the refinancing will go directly to the student loan servicer to fully pay off at least one loan.
The policy change will likely have the effect of greater availability and lower interest rates for homeowners refinancing their mortgage to pay off student debt. Fannie Mae’s announcement expands upon a program launched last year with SoFi to offer a similar product.
Homeowners who tap home equity to pay off student debt give up their rights to income-driven repayment options on their federal student loans, which cap federal student loan payments at roughly 10% of their income. Income-driven repayment is a critical safeguard during periods of unemployment or other income shocks that help avoid the consequences of default. Homeowners may also be trading away loan forgiveness options available to teachers and others who work in public service.
Private student loans generally lack flexible repayment options like income-driven repayment. Borrowers with Parent PLUS loans also have more limited options, compared to other federal student loans.
According to Fannie Mae and SoFi, homeowners with outstanding cosigned student loans had an average balance of $36,000, and those with outstanding Parent PLUS loans had an average balance of $33,000.
Borrowers should also consider the tax implications of refinancing student debt. Borrowers who itemize their deductions and whose income is too high to qualify for the student loan interest deduction may be able to take advantage of tax benefits through the mortgage interest deduction when using mortgage credit to pay off student debt.
Fannie Mae also announced additional guidelines that impact how mortgage originators should consider student debt burdens. Mortgage originators can now consider a borrower’s monthly repayment burden as either the reported repayment level on a consumer’s credit report, 1% of the outstanding student loan balance, or a calculated payment that fully amortizes the loan.
According to data from the National Association of Realtors, 71% of non-homeowners believe their student debt has delayed them from buying a home.
“For too many borrowers, student debt feels like a big barrier to the dream of homeownership. While these changes won’t change those feelings overnight, they may help the mortgage industry adapt to the financial realities of today’s aspiring homeowner,” Chopra said.
The announcement underscores the need for close monitoring by the Consumer Financial Protection Bureau of student loan servicers and mortgage originators. The consumer agency has previously reported widespread failures in the student loan servicing industry, including inaccurate payoff statements and other practices that lead to default.
CFPB oversight will help to ensure that lenders offering student loan cash-out refinance products provide clear disclosures to borrowers and avoid engaging in illegal practices that previously plagued the mortgage market.