|How to pay off debt when getting a home mortgage
Trying to procure mortgage credit right now? From higher interest rates, to rising house prices to the contraction in buying power, securing financing for many can prove to be no easy endeavor. As prices and rates rise in tandem, lenders will still place the weighted emphasis on “real income” as that’s what the mortgage loan is truly made against.
Terms to know
• DTI (debt to income) represents the total amount of monthly debt payment ( plus total house payment) divided into monthly income. Whenever this number exceeds 45 percent of the gross monthly income, things get dicey.
• Real income, also known as “qualifiable income,” is net income considered for the housing payment after present liabilities are factored in. For example, $5,000 monthly income multiplied by .45 percent is $2,250 as a total debt allowance. Less any current liabilities, for example $250 per month, means real income is $2,000 per month. Real income is equivalent to a proposed housing payment.
• Debt refers specifically to the minimum payment obligations for which the consumer is liable. It has nothing to do with total amount of debt, but rather what the monthly payments are. Lenders are looking for cash flow, how much or how little of it there is.
*Tip: Debt erodes income (ability to borrow money) at ratio of 2 to 1 (it takes $2 of income to offset $1 of debt).
Paying off debt to qualify differs from home buying to refinancing. With home buying, paying off debt to qualify is simply a function of learning how much more in purchase price is achievable if the debt was eliminated. A mortgage company can run scenarios like this, showing you “what if” possibilities which could be crucial in your endeavor to purchase not only the right home, but ultimately the home you can afford.
Let’s say, for example, there’s $6,000 left on a car loan, you have the cash in the bank and the car loan payment is $600 per month. The $600 per month on a car loan reduces your ability to purchase to the tune of over $100,000 in loan amount.
Consider this, $100,000 at 4.5 percent on a 30-year fixed rate mortgage translates to $506 per month, $94 per month less for more advantageous debt.
• How to pay off the debt and still meet the lending credit standard?
When paying it off pre-contract, simply inform your mortgage company and they can do a third-party validation to omit the debt. When paying it off during the loan process, monies will have to be sourced and paper trailed; it’s a little more technical, but permitted. The same goes for credit cards and other payment obligations.
• Refinancing: When you refinance a mortgage and you pay off debt to qualify, lenders are going to require the credit obligations such as credit line or credit cards, for example, be paid off in full and closed to prevent the future possibility of further debt accumulation thus impacting the future debt to income ratio as well as the future ability to repay.
Paying off debt to qualify when refinancing will vary from lender to lender as to their specific approaches, but generally, the accounts will have to be closed as well. Nothing, however, prevents you from reapplying for credit after the mortgage has closed.
• How to pay off the debt and still meet the lending credit standard: Monies similar to a purchase transaction will have to be sourced, as well as proof the obligation has been closed.
Tip: If possible, pay off the credit card in full, learn the date the creditor reports to the bureaus, then apply for the mortgage after the creditor has reported to the bureaus. Doing this will show the updated balance on the credit obligations, which will improve real income (by showing less debt), making the process more streamlined.
If you have debt that otherwise could be eliminated and have the means to pay off the debt, strongly consider doing so, as higher credit risk mortgages tend to be quite pricey overall, compared to lower debt to income ratio credit profiles.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.