New Student Debt for Mortgage Swap Program

Last week Fannie Mae announced an expansion of its student loan refinance program and shed light on new policies designed to help borrowers with student debt become qualified for mortgage loans.  “We understand the significant role that a monthly student loan payment plays in a potential home buyer’s consideration to take on a mortgage, and we want to be part of the solution,” said Jonathan Lawless, vice president of customer solutions at Fannie Mae.

Fannie Mae’s new expansion includes a student loan cash-out refinance that offers homeowners a new way to pay off high interest student debt.  The program works by homeowners refinancing their homes, and the bank sending the money to the student lender to completely pay off at least one loan.  Currently, interest rates for home financing are below 4 percent, meaning it could save a borrower money (many student loans are topping 7 percent).  For some, it may be a faster way to consolidate student loan debt at a lower rate.

However, by moving debt from a student loan to a home loan, borrowers lose protection.  Student loans usually offer the option of an income-driven repayment plan or a deferral for financial difficulties.  Mortgages do not.  Rohit Chopra, senior fellow at the Consumer Federation of America, says “Once you refinance and put it into your mortgage, you’re putting your house at risk.”  Chopra expects the first users of the system will be parents who took out loans for their children’s education.  These borrowers are more likely to pay high interest rates and have plenty of home equity.

Another new policy is a ‘debt paid by others’ solution that excludes non-mortgage debt — like car loans, credit cards, and student loans — paid by someone else (steadily for 12 months) from a borrower’s debt-to-income ratio.  This is designed to improve the debt ratios of young buyers and widen their eligibility to qualify for a home loan.

According to Lawless, Fannie Mae started the new programs to help offset the negative effect student debt was having on the housing market.  “We arrived at these product ideas after seeing the size of student loan debt, which is $1.4 trillion.  But there’s another number to pay attention to – the $8 trillion in home equity,” Lawless said.  “There is enough housing equity in California alone to pay off the student debt of the entire nation.  We wanted to find a way to unlock that equity.”

Some lenders aren’t as enthusiastic about the changes. According to the Chicago Tribune, Steve Stamets, senior loan officer with Mortgage Link, worries about the sheer size of some student’s debts. He said previously these applicants couldn’t be approved under the old rules and now will qualify under the new program.  If borrowers have trouble making full payments on mortgages, they could end up in default on their home mortgages.  Fannie Mae expects mortgages that originate using the new system to have low default rates, and notes applicants must still meet regular credit score criteria.  Rhohit Chopra, with the Consumer Federation of America, says “the jury is still out” on whether the program is a good thing.  “New products and financial innovation can help borrowers save money,” he says, “but they can also be prone to abuse.”

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