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Income-Driven Repayment Plans Don’t Always Help Debtors Afford Homes

It’s often a challenge to discharge student-loan debt in a New York bankruptcy case, which is why I have consistently recommended debtors with federal-education loans choose income-driven-repayment (IDR) plans if they find their monthly payments difficult to afford. These plans reduce monthly payments to a fraction of ten-year repayment plan and offer loan forgiveness after twenty or twenty-five years. Aside from the future problem of a tax liability for a forgiven debt, at least for debtors with large loan balances, IDR plans are the next best thing for federal-student-loan debtors than a chapter 13 New York bankruptcy. This doesn’t mean IDR plans solve all of debtors’ problems. In fact, The Atlantic recently discussed a new problem encountered by debtors on IDR plans: Banks won’t lend them mortgages.

(Note: In past years IDR plans were called income-based repayment (IBR) plans, but because IBR is now merely one type of plan, it’s no longer the generic term for the program.)

Apparently, when lenders look through mortgage applicants’ files, they do not account for the repayment plans student-loan debtors are on. As a result, when debtors indicate they have significant student loans, the banks treat them as though they’re paying the maximum amount per month. In other words, they simply look at debtors’ debt-to-income ratios and conclude that they are credit risks.

Although it’s clear banks should be looking at actual monthly loan payments rather than a big debt figure to calculate them, there are a few reasons to understand why the banks would be hesitant to lend to student debtors, other than inertia from past practices. One is that IDR plans require tedious paperwork, and in some years debtors have needed to scramble to ensure they qualify. Two, IDR debtors’ incomes can fluctuate, and their monthly payments might not catch up. For instance, many debtors pay nothing in the first years of their plans as their last known incomes were nil because they were in school. Finally, there is the risk that the government will modify the terms of IDR plans in a way that disadvantages debtors. Normally this isn’t possible for contracts, but the federal government’s contracts with student-loan debtors work differently.

Some lenders, though, have caught on, namely Fannie Mae and Freddie Mac, the federally controlled mortgage lenders, began taking repayment plans into account when assessing borrowers’ risk levels. The Federal Housing Authority, by contrast, has not, citing a 2013 bailout that has left it risk averse. Private lenders’ practices vary.

The Atlantic article is here.

There isn’t a whole lot student-loan debtors can do to obtain a mortgage if their debt-to-income ratios are high, even if their IDR plans greatly deflate their monthly loan payments. Aside from the obvious advice of discouraging people from taking on needless student loans, particularly Parent PLUS or Grad PLUS loans, one thing debtors can do is save up more money for a down payment. It may seem unfair, but if Fannie or Freddie loans are out, it may be the best debtors can hope for.

If you are struggling under significant student-loan debt, then talking to an experienced New York bankruptcy lawyer can help you assess your options. A chapter 7 bankruptcy can free up money dedicated to other debt payments that can go to your student loans.

For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.

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