Student Loans Matter
The Wall Street Journal recently reported that 43% of the 22 million people with federal and private student debt are not
making their monthly loan payments. This includes those who are in default (more than twelve months late), delinquent (more than one month late), or received permission to postpone their payment due to economic hardship. It’s no wonder lenders have tightened their related underwriting requirements!
Some say the consequences of simply assessing a higher default rate of interest is not harsh enough. Others say student borrowers are more apathetic now because they are in the same boat with 10 million others – and the problem is just too large to penalize everyone.
A lender cannot generally repossess a borrower’s car or other assets in the event of a student loan default. But to recoup losses, the government is now garnishing wages and withholding tax refunds once students commence a job after graduation.
When seeking mortgage pre-qualification, applicants have not been required to include deferred student loan payments in their debt-to-income ratio calculation – provided the deferral was for more than 12 months beyond the proposed mortgage closing date. Now, FHA lenders will generally use the known monthly payment or 2% of the student loan balance – versus conventional lenders using the greater of the actual monthly payment or 1%. Assuming a $37,000 deferred loan (the average U.S. student loan balance today), suddenly having to include a 1% or $370 monthly projected payment would certainly have an adverse effect on a mortgage qualification ratio.
Here’s the Point: Even when your student loan is deferred, lenders are now likely to take the projected monthly payments into consideration when qualifying you for a mortgage.
OOPS: I Bought My Rental Property in an LLC…
If you own title to a residential rental property via an LLC (“limited liability company”), then you better have owned this asset for at least 24
months and reported it on Schedule E of your 1040 tax return – otherwise you will have a tough time utilizing the income from this property to qualify for a loan. Without the 24-month seasoning period, there is a good chance the net rental income cannot be used in calculating your Debt-to-Income ratio (DTI) unless you elect to transfer title from the LLC to your individual name.
Now don’t rush out and transfer the ownership from the LLC to yourself personally without first consulting with your accountant and lawyer – especially because of the potential tax ramifications and liability risks. But you won’t get conventional residential financing for your LLC rental property, because the lender will treat it as if it were a commercial property (which means lower LTV requirements and higher pricing – even if you personally guarantee the loan).
On the other hand, if title is in your name, then typically 100% of the income and expenses on Schedule E can be used to calculate your DTI – without having to comply with the 24-month rule. In addition, if the property is so new that it has not yet been reported on your previous tax return, then some lenders will allow you to use 75% of the revenue (confirmed via the lease) less PITI, with only 75% used to account for other standard expenses you will incur.
Here’s the Point: Many of my clients can’t conventionally finance their LLC-owned residential rental properties because they haven’t owned them long enough. If you plan to finance the purchase of one or more of these assets, then in conjunction with your advisor you might consider owning them in your name as opposed to in an LLC.
