Buying a house with student loans in default can be done, but you’ll likely need to deal with the default first.
Buying a house with student loans in default is possible, though you may need to work with your loan officer on a strategy for qualifying.
Defaulting on student loans – or any loans, for that matter – can hurt your credit score and credit history.* Both of these affect your eligibility for a mortgage loan. If you are currently in default on student loans, or you have defaulted in the past, it’s a good idea to connect with a loan officer as soon as possible so they can advise you on the next best steps.
How defaulting on student loans affects your credit
When you default on a student loan – which typically means you haven’t made a payment for 270 days – the default gets reported to the three credit bureaus (TransUnion, Equifax and Experian). The default can drag down your credit score and remain on your credit history for several years.
Mortgage lenders use your credit score and credit history to determine whether you qualify for a mortgage and what your interest rate will be. Most loan programs have a minimum credit score you must meet, and having a low score can cause you to get a higher interest rate. A higher rate not only means you’ll pay more over the life of the loan, but it can also reduce the amount of money you’re able to borrow since interest is calculated into your debt-to-income ratio (DTI).**
“Defaulting on a federal student loan can cause your credit score to drop by 100 to 200 points or more, plunging it into the subprime range, which makes you appear as a greater credit risk to lenders,” says Mark Kantrowitz, president of PrivateStudentLoans.guru.
There are other negative effects of defaulting as well. Once you default, you are no longer eligible for deferment, forbearance or alternative repayment plan options. The entire balance plus interest also
becomes due immediately. This can create tremendous financial pressure and make it difficult for you to save a down payment plus closing costs to buy a house.
Additionally, your wages may be garnished and the federal government may be able to withhold your tax refunds to apply to your unpaid student loan balance.
All of these measures can make it difficult to stay on top of your bills, which can further affect your credit and make it more challenging to buy a home. If you have to go to court over the unpaid balance, you may also be responsible for the court costs, collection fees and other costs associated with your case.
If you default on federal student loans, you could also struggle to qualify for government-backed home loans.
“When you go into default on a federal student loan, you are put into a national system called CAIVRS that flags you as a defaulter, making it really difficult to get approved,” cautions Alex Capozzolo, co-founder of Brotherly Love Real Estate.
If you appear as a defaulter in CAIVRS, you are usually not eligible for any government-backed financing. In these instances, you will be required to settle the default by paying off the loan or establishing a repayment plan.
Note, however, that the CAIVRS database only applies to some federal debts. A default on a private student loan would not show up in CAIVRS.
Buying a house with student loans in default is possible. Here’s how.
You can buy a home even if you have defaulted on your student loans. The first step, however, is dealing with the default.
One option is loan consolidation, in which you take out a new loan to pay off your defaulted federal student loan. It’s very important that you make your new loan payments on time to rebuild your credit and avoid another default.
Alternatively, you can explore loan rehabilitation.
“In this process, you must make nine out of 10 consecutive, on-time, full, voluntary, reasonable, and affordable payments. After that, the default will be removed from your credit history, and you will be returned to a current status,” says Kantrowitz. “You may be required to repay your student loan under an income-driven repayment plan. But realize that this is a one-time opportunity. If you default again, you will not be able to rehabilitate your student loans again.”
If you are able, you can also pay off the total amount owed on your defaulted student loan. With this option, any late payments reported by the creditor before you defaulted will stay on your credit file. But the default will eventually fall off your credit history, and you can offset its impact over time by making on-time payments on any remaining credit or loan accounts you have.
You can also request that your student loan lender remove you from the CAIVRS database once you have resolved your default if the removal doesn’t happen automatically.
One of the best steps you can take if you want to buy a home is to talk with a loan officer as early on as possible, even if you don’t think you will qualify for a mortgage right now. At Fairway, loan officers have access to tools to help borrowers strategize on how to get their credit scores into a qualifying range.
Oftentimes, our loan officers can provide guidance and help create a roadmap for how you’ll be able to buy a home. They can also refer you to resources that may help you improve your credit score and credit habits and avoid missteps in the future.
Letter of explanation of default
Once you have resolved your default, it can remain on your credit history for several years. Therefore, your mortgage lender may ask you to write a letter of explanation for why the default happened and how you will avoid default in the future.
If you’re asked to write a letter of explanation, don’t panic. It’s actually an opportunity for you to clarify what was happening in your life when the default happened and how your circumstances have changed. Perhaps you were out of work during that time or an illness caused you to fall behind on payments. You can explain that you’re in a more stable financial situation now and that you have taken steps to bring all of your accounts current.
If you are still unable to qualify for a mortgage loan on your own, you might consider asking a trusted relative or friend to co-sign the loan for you.
The bottom line on buying a house with student loans in default
Defaulting on student loans won’t make it impossible to purchase a home, but you will need to deal with the default before you can get approved for a mortgage.
“I suggest contacting your student loan lender, learning what your options are, and attempting to work something out,” suggests Capozzolo. “Work to solve the student debt problem first and improve your credit.”
*Fairway is not a registered or licensed credit repair organization.
**Debt-to-income (DTI) ratio is monthly debt/expenses divided by gross monthly income.
Copyright©2023 Fairway Independent Mortgage Corporation. NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-866-912-4800. All rights reserved. Fairway is not affiliated with any government agencies. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.
Fairway is required to disclose the following license information. AZ License #BK-0904162; Licensed by the Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act, License No 41DBO-78367. Licensed by the Department of Financial Protection and Innovation under the California Financing Law, NMLS #2289. Loans made or arranged pursuant to a California Residential Mortgage Lending Act License; Georgia Residential Mortgage Licensee #21158; For licensing information, go to www.nmlsconsumeraccess.org; MA Mortgage Broker and Lender License #MC2289; Licensed Nevada Mortgage Lender; Licensed by the NJ Department of Banking and Insurance; Licensed Mortgage Banker-NYS Department of Financial Services; Rhode Island Licensed Broker & Lender; Fairway Independent Mortgage Corporation NMLS ID #2289 (www.nmlsconsumeraccess.org).