Debt to Income Question w/ Student Loans

[Anonymous]

I finished college in 2004 and started grad school in 2006. During 2006, "things happened" and my student loans defaulted.

I managed to get them all refinanced and in good standing in 2013. The last of the collections information from the default actually SOL'd off of my report not long after that - so I was actually better off for not having tried to pay them at all until I could refinance.

So basically as far as my credit is concerned my student loans go - they're marked paying as agreed. There old closed accounts that appear in "good standing" despite the default, since the status is simply closed for transfer, and the late pays have fallen off.

The problem is that when the loans went default, and I refinanced through the Dept of Ed program, the principle of the loans balooned from $50,000 to around $95,000. Now, I don't recommend anyone ever take out $95,000 in student loans - and I didn't. But you know how it works.

What I'm worried about is Debt-to-Income Ratio now. If you merely look at the total amount owed it looks like I'm too debt heavy. But in reality, I'm on an income-based payment plan that keeps my monthly payments WAY below what they would be otherwise. As in, I'm actually payin a smaller payment per month (for the next 25 years!) and after that the remainder will be forgiven. 

If you simply look at balances - and MyFico and CreditKarma do this - my Debt to Income ratio looks out of whack. In reality, though, I do have enough disposable income to consider buying a less expensive home.

I'm considering applying for an FHA loan this summer, along with a grant that helps teachers with down payment on their home. That looks totally doable, especially as my credit score is improving monthly.  But if they look at my total debt, it's primarily the student loan ($95000) and my car loan ($12000 remaining). Based on the student loan, I'm worried that they'll think my monthly debt costs are much higher than reality since the payment plan isn't detailed on my credit report. 

Should I be worried? What should I do to head off this problem?

[IamB2]

If you are in IBR program, this means that there is a "set" payment that is required each month. This means that the "payment amount" on your credit report will show whatever you are paying per month. I could be wrong, but calculating the DTI is based on your monthly income / monthly expenses.

Example:

Monthly Income: $5,000 (round number based on $60K annually)

Student Loans: $500/month (again round number)

Car Payment: $400 (round number)

All Credit Cards: $800

Second Car Payment: $300

... you get the picture.

Based on the information above, you have $5000 in income (before taxes) and $2000 in set expenses/monthly obligations. This makes your DTI come up to: 40%. (Expenses / Income).

For home purchases though, they will also add your mortgage + taxes + Insurance (or the final monthly payments if taxes and insurance are escrowed) in your monthly expnses.

Of course I am no expert by any means, but this is based on my understanding and based on what I just went through myself. I am sure someone will jump in and inform us if they have a different or better take on things.

Hope that helps.

[Anonymous]

I'm actually a little better off on the DTI ratio than that. Currently my IBR payment is around $200/month though it might go up in November as my pay has gone up. Car is $287/month as I financed sensibly. Credit card debt is under $2000 and all current. The only ghost in the closet I have is a nagging collection from Time Warner that was added back to my report AFTER I had successfully disputed it previously. No second car, etc. 

[IamB2]

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@Anonymous wrote:

I'm actually a little better off on the DTI ratio than that. Currently my IBR payment is around $200/month though it might go up in November as my pay has gone up. Car is $287/month as I financed sensibly. Credit card debt is under $2000 and all current. The only ghost in the closet I have is a nagging collection from Time Warner that was added back to my report AFTER I had successfully disputed it previously. No second car, etc. 

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Right on. As for Time Warner collection, when the time comes for your mortgage, you may be asked to pay that before closing. Other than that, you seem to be in decent shape. Remember, your DTI can not exceed (I think) 45% maximum for a conventional loan. FHA may be different.

Remember the 95K may be a lot of debt, but the way FICO looks at it as this (student loans are considered Installment loans): 

How much of the installment loan amounts is still owed, compared with the original loan amount

For example, if you borrowed $10,000 to buy a car and you have paid back $2,000, you still owe (with interest) more than 80% of the original loan. Paying down installment loans is a good sign that you're able and willing to manage and repay debt.

(see http://www.myfico.com/crediteducation/amounts-owed.aspx)

[SCF]

You may want to visit with a potential mortgage lender to compare your options under different programs.  Some programs/lenders will look at your IBR payments.  Others will only want to consider the payment plan if the payment is good for X months/years and may use a more conservative formula of a % of the balance to estimate your DTI from the loan.  From the reading I've done, it varies widely from program to program and bank to bank, so it may pay to put in some research time now and limit your applications to lenders that will use those IBR payments as the standard.