Debt to Income Ratios – Answering First Time Buyer Questions

NOTE:  This article originally appeared on BuyWiseMortgage.com, and has been republished here with permission from the authors.

Ask a Mortgage Broker – Part 2 – Adrienne Markes is a Realtor friend of ours in Southern California.  Adrienne reached out to her social media followers and told them that she was going to sit down with a lender, what questions do you have?  Topics Include:

• Working with a Pro?
• Working with a Mortgage Broker
• First Time Home Buyer Questions
• Income Qualifying Questions and Answers
• What Does Debt to Income Mean?
• Are My Student Loans Included in My Debt to Income Ratio?
• Can I Count Roommate Rent as Income?

Working with a Pro?

Adrienne Markes is a Realtor in South Orange County, San Clemente area of California.  Adrienne is a professional that understands the value of educating and empowering consumers.  It’s crazy that as a consumer, you are afraid to talk to a loan officer because they typically come off as pushy and salesy…..You’re not wrong.  It’s gross.

Any lender that you hear about on TV, or through an advertisement of any kind, is dumping you into a call center, and you’re connected with someone trying to meet their sales quota for the month.

As a professional independent mortgage expert, sharing what I’ve learned in over 20 years in the business is the best way that I can give back, and try to help consumers avoid the challenges that so many run into when they get tricked into working a call center lender.

The fact that Adrienne is committing her time and energy to educate and empower consumers should go a long way toward earning your trust.  She is a true professional in my opinion.  If you’re trying to buy or sell in South Orange County, California, you might want to up look Adrienne Markes!

Working with a Mortgage Broker

If you’re a first time home buyer, it’s important to know the difference between a depository bank, credit union, direct lender, and mortgage broker.  The short and quick of it is that depository banks, like where you deposit your paycheck, do not specialize in specializing.  Depository banks and credit unions typically have pretty tight guidelines for lending.

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While many people feel comfortable getting a mortgage from the place where they deposit their pay checks, my professional experience is that their ability to be creative when it’s required is limited.  I’m typically ok if the depository bank admits that you don’t meet “their guidelines” and that if you go to a mortgage broker you would qualify.  Most loan officers do not have that level of common decency.

Direct lenders suffer from massive overhead and middle management.  The way that direct lenders have had to grow their business over the past 10 years has left these organizations with massive overhead, which is passed through directly to consumers in the way of high interest rates and lender fees.

I always feel better if you’re working with a professional, or an expert at the specific situation that you may present, and there are definitely some great loan officers that work at a direct lender.  But if you can find that same professionalism or expertise from a mortgage broker, you should always get a second opinion.

Independent Mortgage Brokers tend to be entrepreneurial.  We are typically small business owners, and we build our business around a commitment to that kind of high level personal service that only a relationship with a seasoned professional will give you.

Independent mortgage brokers like BuyWise Mortgage have low overhead, no lender fees, access to wholesale interest rates that will often be much lower than if you went to a depository bank, credit union or direct lender.

First Time Homebuyer Questions

In total, this was a one hour interview.  We’ve broken it up into four separate videos so that it’s easier to consume, and more relevant to what you want to learn about.  This particular segment, we talk about down payment assistance programs, closing cost assistance, and how to get costs paid by others!

More Questions and Answers from First Time Homebuyers:

• Ask a Mortgage Broker 1 – Downpayment & Closing Costs
• Ask a Mortgage Broker 3 – Credit Qualifying Q&A
• Ask a Mortgage Broker 4 – How Do I Get Pre-Approved?

Income Qualifying Questions and Answers

Adrienne:         Hi, good morning everybody. My name is Adrienne Markes, and today I wanted to partner with Scott Schang, who is one of my lender friends, and I had this idea a couple of weeks ago, and some of you actually helped me with this.

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I posted on Instagram a question to you guys to ask whatever questions you had about getting qualified for a home loan or buying a house. And so, after I compiled the questions, I got with Scott, and he graciously agreed to let me interview him to get all of your questions answered.

So, Scott, why don’t we get started?

Scott:               Absolutely. And thank you so much for having me here. This is so much fun, and when you told me what you did, I was just so excited, because any opportunity that we have to answer questions and to help consumers when they’re not face to face with a salesperson, and feeling like they’re being pressured, or feel like they’re being told or asked what the salesperson wants them to hear.

So, this is super, super cool, and I think this is indicative of the type of professional that you are. So, it’s an absolute honor and I appreciate you having on me here … or, having me on here.

Adrienne:         Yeah.

Scott:               Let’s, yeah, you want to dive right into it?

What Does “Debt to Income” Mean?

Adrienne:         Okay. So, we’re going to switch gears a little bit now, and talk about income qualifying. So, first question is, what does debt to income ratio mean?

Scott:               Oh, that is such a good question, man. Your people out there are awesome. They’re asking really good questions. So, debt to income ratio is kind of crazy, because that’s actually the only thing that matters when you’re trying to buy a home. And what that is, is that is the maximum payments that you’re allowed to have in order to qualify for a loan.

So, you don’t necessarily qualify for a loan amount, you qualify for a maximum payment amount. And your debt to income ratio is the percentage of all of your debts, so what’s your principal interest, taxes, insurance, mortgage insurance on your mortgage payment, plus anything that shows up on your credit report.

So if you have student loans, car payment, credit cards, utilities, like your car payment and your phone, that’s not included. So anything on your credit report and your entire payment as a percentage of your gross income before taxes, that’s your debt to income ratio.

And depending on what type of program you’re using. So for instance, a conventional program, that total liability, your total payments, cannot be greater than 45% of your gross income before taxes. But if you go to FHA, just your house payment, just the principal interest, tax, insurance, is allowed to be up to 47%, and then you can go up to 57% when you add your bills.

So, it’s funny, people will ask these questions, what’s the best loan for me? What’s the debt to income ratios? Most of this is math and the math determines what your options are. We don’t get to choose our loan. Most of the time, our loan chooses us. So, based on whatever your liabilities, your income, your credit, whatever your credit profile is, your loan will choose you based on I need these flexibilities. So, that is debt to income ratio.

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Adrienne:         Okay. Well, that was a lot to take in, and I guess anyone watching can do a little rewind and listen to it again.

Scott:               I’ve been doing this for 20 years. It’s not a big deal. It doesn’t take that long to look up.

Are My Student Loans Included in My Debt to Income Ratio?

Adrienne:         Yeah. You just rattle it off like nothing. Okay, next one. Are my student loans counted in my debt to income ratio, or when I’m trying to get a loan?

Scott:               This is probably one of the most common questions that I get, with everything that I do. This is a real challenge right now. They changed those student loans, the way that you calculate your payments for student loans, they changed that in 2015, and since then they’ve changed it two or three times.

And essentially, what they were trying to address, as part of the fallout from the crash and the ability to repay on new mortgages, what we used to have is, you would have student loans that were deferred or in forbearance. So, you would have a student loan balance on the credit report, but there would be no payment.

So, in 2015, all of the main lenders, Fannie Mae, Freddie Mac, FHA, VA, USDA, they all came out, and they came up with estimated payment calculation for all of these student loans. And the big, big challenge that hurt most people was, if there was no payment showing up on the credit report, you have to use 1% of the balance of your student loan balance when calculating your debt to income ratio.

So, let’s just sort of play this out a little bit. I think on average, I see student loans above six figures, like on average, it’s just, that is not unusual. I’ve seen couples as high as a million dollars. They were attorneys.

Adrienne:         Whoa!

Scott:               Yeah, crazy. And we got them … and we got the loan done. So, there’s a lot of different rules around student loans. So, each, depending on what type of loan that you’re trying to qualify for, they’re going to calculate your payments differently.

FHA and USDA, you have the payment … you have to use a payment that will pay off the loan at the end of the term. It cannot be deferred. It cannot be in forbearance. If it’s deferred or in forbearance, they’re going to use 1% of the balance as a calculation.

If you have an income-based repayment, IBR payment, which is really, really common right now, your only options are conventional. So, Fannie Mae will allow an income-based repayment, and Freddie Mac will allow an income-based repayment. So, depending on what type of loan chooses you, or what type of loan you qualify for, you have to follow those, those guidelines.

So, yeah, student loans are absolutely going to impact your ability to qualify. That’s a fairly new thing. There are a lot of loan officers and a lot of lenders that either, A, they’re not up on the guidelines, so they’re giving consumers bad information.

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So, you’ll hear 1% rule. So, if you’re talking to a lender, and they say, “Oh, we need to do 1%,” tap the brakes a little bit and talk to somebody that might have more experience with student loans.

The other thing is, some lenders choose not to follow those guidelines. So, for instance, if you go to like, Bank of America, if you do not have a payment that pays off the loan at the end of the month … or, at the end of the term, they’re going to use a one and a quarter percent calculation to qualify your payment. Wells Fargo, the same way. Doesn’t matter if it’s income-based, they will not follow Fannie Mae guidelines. They’re going to require you to use the 1% or a fully amortized payment.

So, ask questions. But no, absolutely, I would say student loans are probably one of the most important factors in qualifying for a mortgage today, and I think even into the future.

Adrienne:         Yeah, yeah. Well, it’s really important for people to understand how that can impact them when they’re trying to get a home loan. So, thanks for going over that in great detail.

Scott:               Yeah. I’ve got some really great articles on my site that breaks down all of those programs, so you can share that with your listeners and your followers if you want. I’ve stayed on top of this topic since 2015. Every time there’s a change, we update it. So, it really just breaks it down by every single loan program and what the guidelines are.

Adrienne:         Yeah. And I have gone onto your website quite a bit, and you do have some very informative articles, so I’ll make sure that we have a link, so that people know where they can go to find all these great blogs that you’ve written. And what is your website, by the way?

Scott:               It’s FindingMyWayHome.com

Adrienne:         Okay, that’s perfect.

Scott:               It turns out, not only can I talk a lot, I can write a lot, too.

Can I Count Roommate Rent as Income?

Adrienne:         That’s okay. I still like you. All right, so, this is an interesting question. If I plan to have roommates, can I count their rent as income?

Scott:               Yeah, that’s a really good question. And you know, this is, there’s another layer to this question, and it’s kind of like AirBnB, right? So, if I rent out one of my rooms, can I use AirBnB income for that?

So, that is considered variable income, and with all underwriting guidelines, you typically have to have a history of it. So, you cannot buy a home and just say, “Hey, I’m going to rent out a room and here’s how much I’m going to rent out the room for.”

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But if you are renting now, and if you rent out rooms to roommates, and you report that income on your taxes … essentially, if you can show that you have a two-year history of collecting rents from a roommate, then you can use that.

But just to say, “I’m going to have somebody,” or just to say, “I’m going to use Airbnb,” those are amazing opportunities to reduce your payment, but they’re really not going to help you when you’re qualifying. It gets very, very difficult. You’d have to show a history, and you’d have to document that income before you can use it.

Adrienne:         Okay. So, two years history, and you have to report the income on your taxes in order for it to be counted. Is that right?

Scott:               And then, you’re going to average that income over that two year period. And that’s how they’re going to treat any variable income, they’re going to treat, like commissions over time, they’re going to treat that type of income the same way.

That’s the tough thing about mortgages, is we have underwriting guidelines. They’re not rules. They’re literally just guidelines, and you have to be able to operate within those guidelines. You have to be able to read between the lines and decipher them.

And when we talk about roommates, what we’re really talking about is potentially variable or temporary income. So now, you’re going to the variable and temporary income section of the guidelines, and that’s where you’re finding the answer for that type of question.

Adrienne:         Yeah. Okay. Perfect.