Applying for a mortgage is like going out on a date - you want to look your best!
You may think you look your best with the documentation you have provided. The lender, however, may pick up on some "blemishes" that you have that you may not be aware of.
The formula to qualify for a mortgage is pretty simple - monthly debt payments divided by gross monthly income. The numbers behind the fomula is where I find there is a lot of confusion.
Not only is there confusion, there are also well intentioned decisions made that may make perfect sense by themselves, but in the context of applying for a mortgage don't make sense.
Let's look at some of these examples of responsible financial decisions that actually reduce the amount of mortgage you can qualify for:
We have been taught that we should pay off consumer debt, such as credit cards and car loans, as quickly as possible. We are offered car loans with terms from three years to seven years.
Being financially responsible, we often choose the shortest term for the car loan that we can afford.
The problem with the short term is that the car loan payment is usually higher with a shorter term than the payment with a longer term.
You as a consumer don't look any better to the lender with a three year car loan than a seven year car loan - all they care about is the monthly payment, which they include in your debt-to-income ratio.
Form 2106 Business Expenses
I ask my clients when they first contact me "What is your gross monthly income?" They answer with an amount.
I then ask them "How much are your Form 2106 Business Expenses?" They often don't know what I am even talking about!
Form 2106 is a tax return form that details business expenses of an employee that are not reimbursed by their company. These expenses are subtracted from the gross monthly income of the mortgage applicant!
Taxpayers file this form in order to reduce their taxable income. We all want to reduce our taxable income in order to pay less taxes.
However, the 2106 expenses increases the debt-to-income ratio of a mortgage applicant because the gross income is reduced by these expenses!
A 401K loan is not reported on your credit report (as far as I know). However, they are a deduction on your paystub. Some loan programs require that this payment be added as a monthly debt in the calculation of your debt-to-income ratio.
Declining Commission or Bonus Income
If you have done any research on how lenders calculate bonus and/or commission income you probably will have found that they generally use a twenty four to thirty six month average. There is a caveat to that generalization - if the bonus or commission has declined in the most recent year used, that year is used rather than an average. In addition, you may be asked to write a letter of explanation stating why the amount has declined!
Related Post - The ABC's of DTI's (Debt to Income Ratios)