Mailbag: Getting Federal Loans Ready for a Mortgage Application

Michael Lux Blog, Mailbag, Student Loans 0 Comments

In this week’s mailbag we take a look at Jim’s student loan situation.  Jim is currently dealing with a Navient screw-up on his IBR plan and is worried about how applying for REPAYE would affect his mortgage.

Jim Writes:

Dear Sherpa,

I am in the unfortunate situation of needing to consider how federal consolidation may affect my ability to obtain a mortgage. My wife and I were planning on buying a new house at the end of December 2016 – January 2017 timeframe. As the realtor advised, we will seek pre-approval in late November 2016. For the reasons explained below, I need to consider re-financing my federal student loans under the REPAYE plan, which, I hear, can be a lengthy process – up to 3 months – and can result in an “administrative forbearance,” which then results in the standard repayment amount being reported to credit agencies as a monthly obligation instead of the much lower REPAYE monthly amount.

My story: I have roughly $102,000 in federal loans (undergrad and law school); my wife has about $11,000 (undergrad). My payment under IBR has been about $326/month – until now. Some of my Navient-serviced loans had a variable interest rate since they originated prior to the advent of the fixed 6.8% Stafford loans. The rate increased in July 2016, and so did my payment, by about $15/month. Thinking my payments ought not increase under IBR if my income hasn’t increased, I called Navient. The representative was helpful and apologetic. What I needed to do was agree to a one-month forbearance while they fixed it, said Navient. Sounds good to me. Do you agree to the following terms? Sure, as long as my payments get fixed.

Fast-forward: My new, recalculated bill is now $421/month – Navient’s fix for my $15/month increase is a $95/month increase. Navient!? How did this happen? Well, you agreed to capitalize seven years’ worth of interest, says Navient.

I don’t recall whether the words “capitalization” and “interest” were spoken in the same sentence in the phone conversation in July; even if they were, I still don’t see how my payments under “income-based” repayment should increase if my “income” doesn’t. Perhaps “income-based” is more figurative than literal. Perhaps IBR should be renamed, through Congressional action, “IB”R.

Nonetheless, I now notice that on my Navient account history, there is an item for capitalized interest in the whopping amount of “$0.00.” No one at Navient can explain this – no interest has been capitalized, my balance has not changed, my income and family size have not changed, but my payments have. I have submitted what they call a “research request” for a formal explanation, but the best option, they tell me, is consolidating and choosing REPAYE so that my monthly payment is only based on 10% of my discretionary income. My options, barring a change of heart by Navient, are to shoulder an extra $95/month – a 29% increase in payment – or risk the alleged woes of consolidation to reduce my payments.

Are you aware of any information that the REPAYE application process through consolidation has improved? Are you aware of any similar experiences?

Any insight would be appreciated. Thanks.

The Plan

Jim has two major issues with Navient.  Issue one is their inconsistency with information and results on an IBR application.  Issue two is getting signed up for REPAYE in advance of a mortgage application.  Both of these issues are very difficult to address.  Fortunately, if Jim takes care of issue number two, the IBR errors will no longer matter.

Signing up for REPAYE and your Mortgage

This is an issue that I personally faced this year.  The process of getting signed up for REPAYE can be very slow.  Getting mortgage companies to accept your REPAYE payment can be incredibly difficult, and impossible with many lenders.

We have previously detailed the REPAYE mess with myfedloan, but these issues are not constrained to any one lender.  Processing times with REPAYE applications are incredibly slow.  Because of the realities of the mortgage process, you will want to have your new REPAYE payment calculated and reported to all the credit agencies before you start your mortgage application.

With no definitive timeline, it means you need to get REPAYE started right away.  If you don’t think you can get the REPAYE process completed long before you start your mortgage applications, it may actually make sense just to stay on IBR.  The comparatively higher IBR payment may limit your ability to borrow, but the IBR number is far better than the number mortgage lenders use if you are on a deferment.

Get Ready for a Headache

Mortgage lenders follow very specific criteria for approvals and denials.  This process is called loan underwriting.  Before you start the process, it is important to understand that things like common sense have no place in mortgage underwriting.

Many lenders require monthly student loan payments to be high enough to pay off the loan within 30 years.  If your current IBR or REPAYE payment will not pay off the loan balance within 30 years, they may use a higher monthly payment when calculating how much of a mortgage you can be approved for.  This standard is relatively new, so it is possible that your loan may slip through the cracks, but only if the IBR/RPEAYE number appears on all of your credit reports.  If you have a deferment or another number on your credit reports lenders will almost never take your new IBR/REPAYE number.  It is for this reason that student loan issues must be addressed long before the mortgage application process starts.

The worst case scenario is that mortgage lenders will just take 1% of your principal loan balance.  In Jim’s case, they might use a monthly payment of $1,020 per month on his federal student loans.  This would dramatically limit his ability to borrow for a mortgage.  Loan underwriters love to use the 1% figure because it makes doing their math easy and they will never get in trouble for using that number.  Convincing them to go with another number, even if you have a letter from your student loan company, is very difficult.  Again, the key is making sure your credit report shows the monthly payment you want lenders to use before you ever apply.

The thing that worked for me was applying with several different lenders at the same time.  Some of the unexpectedly changed their minds at various points, but by going through the process with a few lenders, not only can you shop rates, but you have a backup plan in place ready to go.

Fixing the Navient Screw-ups

If Jim has decided to switch to REPAYE, there is really no advantage to trying to get the IBR payment corrected.

However, letting Navient slide on this issue also seems unacceptable.  Especially when they tell you one thing, it turns out to be wrong, and it costs you money.

A good option to see to it that Navient faces a little accountability would be to file a complaint with the consumer financial protection bureau.  It provides the government further evidence of the issues with the current federal student loan system and it forces someone a little higher up at Navient to take a look at what happened with your loan.

The Bottom Line

If you are on an income based repayment plan and trying to buy a house, the process can be long and painful.  Expect headaches and heartache.  At the end of the day, the best you can do is to jump through all the hoops the various lenders require and hope for the best.