Getting a mortgage can be difficult. Sometimes, to increase the odds of being approved or to qualify for a larger loan, prospective borrowers will pay down debts or eliminate existing loan obligations. Often, the process for doing so is simple, but there's one type of financing that could trip up your efforts: a car lease.
Here's a breakdown of why -- and what you can do to avoid any snags.
What's your debt-to-income ratio?
When you apply for a mortgage, a broker is going to tally up all of the monthly payments you make on existing obligations, including credit cards, student loans, personal loans, car debts, and other mortgages. That number gets measured against your income. This debt-to-income ratio helps determine your monthly mortgage payment. (So does your credit score. You can see where yours currently stands by getting your free credit scores, updated each month, on Credit.com.) Sounds easy and simple enough, right?
Well, the concept is, but if more than 25% of your income is already going toward debts, you may not be able to buy as much home as you think. When you have other existing obligations, your ability to borrow can be reduced tremendously. That $300 per month car lease, for example, can be severely hampering your buying power.
Mortgage tip: Remember, lenders will use only what you're obligated to pay on existing loans in calculating your debt-to-income ratio. Choosing to pay more on your debts can be a good financial move, but mortgage lenders generally don't give you any benefit for choosing to do so.
Why a car lease can trip you up
Unlike an auto loan, a car lease can be trickier to work around if you're trying to pay off debt to qualify for a mortgage. Let's say your credit report shows a car lease payment of $300 per month. There is a balance on the credit report of $6,000 due, which is the remainder of the lease. If you had a car loan with these exact terms, you could write a check to pay off the $6,000 obligation. Case closed.
Unfortunately, that option doesn't apply to a car lease. You can give the car back and pay the $6,000 balance that is due. However, to qualify for a bigger mortgage, the lender will need to verify there is no obligation due for car. If you give the car back, the mortgage company may ask what you're going to drive instead -- especially if there is a commute time from where you work to where you plan on residing.
Should you find yourself in this predicament, here are some options to consider.
- Call your car dealer. You can ask if it has any specific options for getting out of the lease. You'll need to make it crystal clear that you must be out of the lease obligation completely.
- Transfer the lease to someone else. Your mortgage company should be OK with this option as long as you can show and verify the obligation is completely out of your name and that there is no obligation associated with it. You can search online for options if your car dealer doesn't have any transfer suggestions.
- Pay out. Give the car back, pay the balance due, and either buy a new vehicle in cash, removing any debt-to-income ratio predicament, or finance a car that has a lower monthly payment. The key here is that the payments need to be reduced or totally removed if you want to maximize your buying power.
- Consider your priorities. A great deal on your car lease may not matter if you are serious about buying a home, plain and simple. Ask yourself: Is the car more important than the house?
Paying off debt for a mortgage
Paying off debt to qualify for a mortgage usually needs to be documented in the following ways.
- Money used to pay off the obligation cannot come from the reserve requirement your lender almost certainly has. Lenders usually want you to have at least three to four mortgage payments in the bank, called reserves, as a cushion when granting your loan request.
- You'll need to produce a paper trail showing money leaving your bank account and going to the creditor to pay off debt or provide a copy of the canceled check to show you no longer owe the obligation.
All of these steps may seem unnecessary and overly repetitive, but they are a byproduct of the current mortgage lending world. Remember, stringent underwriting requirements help to ensure lenders are making good loans and, more importantly, that you can actually afford the house you are looking to buy.
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