How to Buy a Home When You Have Defaulted Student Loans

For some young Americans, buying a home is considered a rite of passage. But for those who have defaulted on their student loans, it is one that they may have to be put off until they can resolve their default issues.

It is important to know that federal student loan debt is not dischargeable in a bankruptcy nor does a statute of limitations apply. Therefore, the debt will not disappear over time as is the case for some other types of debt. For this reason, consumers who have defaulted on their federal student loans will be unable to secure an FHA mortgage loan.

[Read: How Student Loan Debt Is Different From Other Types of Debt.]

For many first time homebuyers, an FHA loan can be an easier loan to qualify for, offering lower down payments, lower closing costs and easier credit qualifying.

The Federal Housing Administration is part of the Department of Housing and Urban Development. Anyone applying for an FHA loan must clear the Credit Alert Interactive Voice Response System.

CAIVRS is a database created by the federal government that will flag anyone with outstanding federal loan defaults or delinquencies during the qualification process. If a default is present, the application for the new loan will likely be turned down until the old student loans can be moved out of default.

Federal Student Aid, an office of the U.S. Department of Education, offers options to get student loans out of default:

— Loan rehabilitation.

— Loan consolidation.

— Repayment in full.

[Read: How to Manage Old, Unpaid Student Loans.]

Loan Rehabilitation

To rehabilitate a defaulted loan, borrowers must agree in writing to make nine affordable, on-time monthly payments over 10 consecutive months. Loan rehabilitation occurs once the borrower completes these payments.

Once the defaulted loan is rehabilitated, the borrower regains the benefits of deferment, forbearance, choice of repayment plans and loan forgiveness that were lost when the loan went into default. In addition, the record of the default will be removed from the borrower’s credit history, although late payments reported by the loan holder prior to the default will remain.

It is important to note that rehabilitation is a one-time only proposition. If a borrower defaults a second time, rehabilitation will no longer be an option.

Loan Consolidation

Another option for getting out of default is loan consolidation, which involves obtaining a new loan to pay off the defaulted federal student loan. In order to consolidate the borrower has to agree to repay the new loan under an income-driven repayment plan or make three consecutive full monthly payments on the defaulted loan before consolidating.

Like rehabilitation, loan consolidation will reinstate eligibility for deferment, forbearance and loan forgiveness. However, the record of the default will remain on the borrower’s credit file.

[Read: Know When it Makes Sense to Consolidate Student Loans.]

Repayment in Full

Finally, another way to get out of default is to repay the full amount of the defaulted student loan. The late payments reported by the lender prior to the default will remain on the borrower’s credit file but it may be possible to have the default removed once full payment has been made.

While working on getting the default cleared, borrowers can take other steps to improve the chance of qualifying for a mortgage. This starts with credit score improvement, with options such as becoming an authorized user on the credit card of someone who has a good credit score and obtaining a secured credit card.

Borrowers can also consider other home loan options if they have the financial means for a large down payment. Some conventional home loans offer the option of only 5 percent down and are less risky, but borrowers will need at least a 620 credit score to be considered for approval. Also, keep in mind if putting down less than 20 percent, private mortgage insurance, or PMI, will likely be required and increase the amount you pay over time.

The Student Loan Ranger recommends that those in default who are looking to buy a home first decide how they will take care of their student loan default and begin the work of building a good credit score.

Saving for a substantial down payment is also a good idea. Once that work is accomplished, the mortgage process will be much easier and the chances of a favorable outcome more likely.

More from U.S. News

New Homebuyer Programs Help Student Loan Borrowers

4 Things to Think About When Refinancing Student Loans

10 Steps to Develop a Student Loan Repayment Plan

How to Buy a Home When You Have Defaulted Student Loans originally appeared on

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