Ask the Underwriter is a regular column for HousingWire's LendingLife newsletter, addressing real questions asked to, and answered by, professional mortgage underwriter, Dani Hernandez.
Question:
I’ve been hearing about a new cash-out refinance program that is designed specifically for paying off student loan debt. What is the difference between this “student loan cash-out” mortgage and a traditional cash-out refinance? How can I market this to my borrowers?
Answer:
How it’s always been done…
Traditional cash-out refinances have always allowed you to cash in your home’s equity by refinancing your primary mortgage and walking away from closing with a check to use on other expenses, such as costly home repairs or to pay off credit card and student loan debt. However, lenders add a premium to the mortgage rate on a standard cash-out refinance (also called a loan level price adjustment). So, using the equity in your home to pay down student loan debt meant paying a higher interest rate on the full balance of your mortgage loan. The rate increase on a cash out refinance varies from .125% to 1% higher than a non-cash out.
What’s New?!
Fannie Mae's new Student Loan Cash-Out Refinance Program waives this premium and allows homeowners to refinance an existing mortgage and take out extra money to repay student loans!
According to Fannie Mae, the changes :
- Offer homeowners the flexibility to pay off high interest rate student debt while potentially refinancing to a lower mortgage interest rate.
- Widens borrower eligibility to qualify for a home loan by excluding from the borrower's debt-to-income ratio non-mortgage debt, such as credit cards, auto loans, and student loans, paid by someone else.
- Makes it more likely for borrowers with student debt to qualify for a loan by allowing lenders to accept student loan payment information on credit reports.
Interest rates on private student loans can be as high as 8%, compared with under 4% on a 30-year fixed-rate mortgage. If you’re wondering…
How does this all translate to dollars for your borrower?!
Take a look at these two scenarios to see just how much you might be able to save your borrowers by taking advantage of this new program,
Scenario 1: Pay Student Loans and Home Loan
Student Loan total balance: $60,000
Student Loan total monthly payments: $666*
Mortgage balance: $250,000
Mortgage payment: $1,250**
Total Monthly Payments: $1,916
* 10-year term at 6%
**30-year fixed at 4.25% and 4.27% APR
Scenario 2: Consolidate Student Loans into Home Loan
Mortgage balance: $310,000
Mortgage payment: $1,525***
Total Monthly Payments: $1525
***30-year fixed at 4.25% and 4.29% APR
With potential savings like the ones illustrated above…
What are the downsides to refinancing student loan debt into your mortgage?!
You end up with a lower interest rate and more of your student loans paid back, but with a larger mortgage, less equity and lose some protections that federal student loans offer.
A drawback of the program is that by moving student loan debt from a federal student loan program to a mortgage refi is that some federal protections on student debt are lost.
A home loan uses the home as collateral if the loan isn’t paid. Defaulting on a student loan can ruin a credit score, but it usually doesn’t have a home as collateral.
Federal student loans allow payments to be deferred for a job loss, or payments can be lowered if your income drops. Student loans can also be deferred for a year for borrowers who work abroad for a volunteer organization.
Lastly, student loans usually last 10 to 20 years, Lawless says, while adding it to a 30-year mortgage extends it — though at a lower rate.
If the benefits outweigh the risk in your particular situation…
Here’s what you need to know about qualifying your borrowers.
In order to qualify for this new program, certain requirements must be met. A few of these requirements are listed below, but you can find the complete guidelines published by Fannie Mae, HERE.
Borrower Eligibility
Anyone who is legally obligated to repay a student loan is eligible for a student loan cash-out refinance, subject to meeting the borrower qualification requirements outlined below. If co-borrowers are applying for the program, at least one of the borrowers is required to have a student loan.
The student loan cash-out refinance program applies to both students and parents or relatives who have taken out or guaranteed student loan debt for someone else. For example, parents can use the equity in their home to pay off student loan debt that was taken out on behalf of their children.
Use of Loan Proceeds
In addition to paying off an existing mortgage, home equity loan or HELOC on the property, at least one student loan must be paid in full with the proceeds from the loan and the proceeds must be disbursed directly to the student loan lender. Borrowers are allowed to pay off more than one student loan but partial payoffs of student loans are not permitted. Additionally, the borrower cannot personally receive more than 2% of the loan amount or $2,000, whatever is lower, in proceeds from a student loan cash-out refinance.
