The Biggest Hurdle in Mortgage Loan Qualification: Existing Debt
I got a question about what the number one obstacle is to most people qualifying for the loan on the property they want.
The answer is "existing debt." Credit cards, student loans, car payments, etcetera. It seems like more people than not have a reasonable idea of the property people making what they are making might be able to afford. Whereas I do get people who want a four bedroom house despite only making enough to be able to afford a two bedroom condo, it seems that more folks than you'd think really do have an idea what people making what they do should be able to afford. They can be lured down the primrose path of negative amortization, but even most folks who fall for it, know on some level that it's not real. They may not realize exactly how nasty it is, but they know it's not the whole truth.
The real hurdle faced by most buyers is that they owe too much money to too many other people for too many other reasons. Every dollar you have in monthly obligations is another dollar you can't afford on your house payment.
Let's say that Mr. and Ms. Homebuyer make $120,000 per year between them - $60,000 each. They are making $10,000 per month. By the calculations for A paper fixed rate loans, they can afford total monthly payments of $4500 per month. This is a forty five percent debt to income ratio. If housing is their only debt, they easily qualify for a $500,000 property with zero down payment. As of the time I'm writing this, $2367 first at 5.875% with one point, thirty year fixed rate first mortgage, $752 second at 8.25% 30 year due in 15, $521 per month prorated property taxes, and $120 per month for a good policy for home owner's insurance. Total: $3760. They're $740 under their limit. They would actually qualify for a significantly larger loan if they had no other debt.
However, Mr. and Ms. Homebuyer still have student loans, because everyone knows you don't pay your student loans off. Right? But because Mr. and Ms. Homebuyer owe $50,000 between them, and they're paying $180 each, for a total of $360 per month, that's $360 in housing costs they can't afford.
Now Mr. and Ms. Homebuyer both have $30,000 automobiles they're making payments on. On five year loans, Mr. and Ms. Homebuyer are paying $600 each. He has four years to go, she has two. That's still $1200 more in housing costs they can't afford.
Ms. Homebuyer charged their vacation trip to the Bahamas that cost $10,000 to their credit card, and Mr. Homebuyer put the furniture he bought Ms. Homebuyer on an installment plan. The credit card is $500 per month, the furniture is $400. Net result: $900 more that they can't afford for housing payments, because they have to pay it out for existing consumer debt.
By the time Mr. and Ms. Homebuyer have paid all of the monthly payments they already owe, the lender calculates that they can only afford $2040 per month in housing payments. Now, instead of easily affording a $500,000 house, they don't even qualify for a $300,000 condo. $240,000 first at 5.875 is $1420, $466 for the second at 8.625% (below a price break), $313 property taxes and $240 in association dues. Total: $2439! They're $400 per month short!
For people who have a down payment, often the only way they are going to qualify is by spending it on their pre-existing debt. If they don't have a down payment to pay existing debts off, they are not going to qualify "full documentation," which is a fancy way of saying that the income they can prove isn't enough to qualify them for that loan. Furthermore, the manner in which you pay that debt off can be restricted. Sub-prime lenders don't really care as long you can show where you got the money and the debt gets verifiably paid off. "A paper," however, has to deal with Fannie Mae and Freddie Mac guidelines, which are less forgiving. A paper guidelines are that you cannot pay off revolving debt to qualify, and even installment debt is at the discretion of the underwriter. In short, once your credit has been run, what you can pay off to qualify "A paper" is limited. A lot of folks end up stuck with sub-prime loans because of this. Higher rates, shorter term fixed period, pre-payment penalty. Some folks just flat out will not qualify unless they go "stated income," and state more income than they make.
Indeed, this is probably the most common reason why people do stated income loans. However, stated income loans mean that your rate is higher, and you might not be able to use all of the money you were intending to as a down payment, because you've got to have reserves for a stated income loan. Finally, and most importantly, stated income loans are dangerous. The debt to income ratio is not just there for the lender's protection - it is also there for your protection. Stating more income so that you can get around the limits on the debt to income ratio is intentionally disabling an important safety measure, meant to keep borrowers from getting in over their heads with loans and payments they cannot really afford. You make $X, which equates to being able to afford total monthly payments of forty five percent of $X. You state that you make an additional $Y per month so that you qualify for higher payments, and you are intentionally defeating that safety precaution. You are going to have to make those payments. The people who loaned you the money want their payments every month! Where is the money going to come from? I would be very certain I could really afford the payments before I agreed to a stated income loan!
So you should be able to see some of the issues that existing debt can cause. Existing debt quite often means that you do not qualify for a property you would easily be able to afford - if only you didn't have those pesky consumer loan payments every month. It can force you to undertake a less desirable loan type, it can force you to accept a pre-payment penalty, and it can prevent you from being able to qualify for the property you want. Alternatively, it can force you to choose between not buying at all, and intentionally defeating one of the most important safeguards consumers have, the debt to income ratio.
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