If you’re thinking about qualifying for a mortgage, here’s what you must know if you have payments with a few months left to go. Get the facts…
When you apply for a mortgage loan, the lender takes in the consideration your credit score, your cash you plan to use to spend on a home, your credit worthiness, and the amount of expenses you have (including a proposed mortgage payment) against your monthly income. The four C’s of lending include: credit, collateral, capital and capacity and each play a key role in your ability to obtain credit. Liabilities take away your capacity to handle a mortgage payment. If your financial picture represents all your income going to debts with or without a mortgage payment included loan qualifying can quickly become very problematic. Installment loans typically carry the largest monthly payments and hurt your chances of qualifying the most.
Installment loans have a set payment schedule with the loan amount being repaid over time. The most common forms of installment loans include:
- car loans
- personal loans
Picture this scenario- you have a car loan for a monthly payment of $400 per month and there’s just 12 months left on the loan. This will hurt your debt to income ratio. This obligation will count against you in determining how much house you can buy. The payment associated with this installment loan obligation is what the lender uses to determine how much or how little the liability affects your borrowing power. $400 per month can sway purchasing power by as much as $40k, so it does matter! If you have just 9 months left on the obligation, this is where the wheels begin to turn and more leniencies may be granted with conventional financing.
An installment loan with less than 10 months left of payments due may be omitted from the debt to income ratio on a case-by-case basis. How strong the borrower is financially determines decision. Case in point, if a borrower had an installment loan payment as high as 25% of their income, before the housing payment is calculated, that would almost certainly cause the lender to take a more conservative approach and include the liability in the debt to income ratio even if under 10 months. An additional factor the lender will look at would be the amount of reserves the borrower has after-the-fact. If for example this borrower had future reserves such as the amount of their annual income in savings, that’s called a compensating factor which may potentially allow a loan approval with an installment loan less than 10 months, even if the payment is relatively high in relationship to the mortgage payment and the rest of the expenses.
FHA Loans Take A Closer Look
All liabilities must be included in the borrower’s debt to income ratio with one exception, installment loans can be also omitted from the debt to income ratio if the obligations will be paid off within 10 months, and the cumulative payments of all such debts are less than or equal to 5% of the borrower’s gross monthly income.
How does one decide what mortgage loan program makes the most sense for them if they’re trying to qualify the maximum amount of affordable house? An experienced mortgage professional should be able to guide you through what options make the most sense. Generally, the more money you have to spend on buying a home, the more emphasis should be given to conventional financing especially if you have any installment loans with just a handful of payments left. On the other hand, if you’re trying to get your foot in the door, and your income is large enough to support an affordable mortgage payment, and cash is tight, a fixed rate loan insured by the federal government is generally a safe bet.
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