Qualifying for a Mortgage doesn’t mean you can Afford it – June 25, 2013

There has always been a nagging voice in the back of my mind wanting to know why mortgage underwriting guidelines and sound financial planning advice just never met eye to eye.

Should you have been through the lovely experience of qualifying for a mortgage, you would remember how your entire qualification hinges on several ratios, most notably the DTI; debt-to-income ratio. This ratio has 2 forms, a front-end DTI that compares your mortgage payment to your gross monthly income and your back-end DTI which measures all of your monthly debts against your gross monthly income. According to Fannie Mae, the maximum (back-end) DTI ratio for all debts should be 36%, however, they will allow flexibility up to 45% based on compensating factors such as having more cash savings or stellar credit (I would hope both). Mind you, these are all based on GROSS income, that is income before Uncle Sam has taken his cut in the form of taxes. This is where my worries come flooding in.

In my early years while I worked as a loan officer, I just ignored this and based everything on the full faith and omniscient knowledge of Fannie Mae and Freddie Mac’s automated risk-adjusted underwriting system. This system that was similar for both agencies, ran a loan application with a borrower’s credit scores, income information, liquid and illiquid assets and liabilities to spit out a report in a few seconds that indicated if the borrower is an acceptable risk to lend out hundreds of thousands of dollars for the next 30 or so years. It was not until my last few years in the business where I would ask potential borrowers the simple question before starting, “what’s the most that YOU feel you can pay monthly for your mortgage?”

Almost every time, the number they provided me was always below what they would actually qualify for based on underwriting guidelines set forth by Fannie & Freddie. Interestingly, financial planners would generally tell these same people that they should never exceed 36%-38% of their NET (after-tax) monthly income on mortgage debt. That is a huge disparity!

Check out my example to illustrate this better. Both scenarios assume you make salary of $80,000/year in Virginia for state tax purposes.

Using GROSS income, you would qualify for a payment of up to $3,000/month @45% DTI and $2,400/month @36% DTI.

Using NET income, you would qualify for a payment of $1,851/month @38% DTI (recommended by advisers).

This is a variance of almost $550/month or 30% more than what you should be able to comfortably afford.

Why the disconnect? I have no idea, but I suspect it may have something to do with getting people to buy more houses so they pay more taxes and keep the big Federal machine moving; without too much regard on whether they will actually pay back the entire loan. Then again, renters don’t pay any property tax but they are also paying a lot more to rent than ever before, as stated in my prior post.

BOTTOM LINE: Be mindful of your total monthly payment (including any HOA or condo fees) more than your interest rate when you take on that mortgage debt, you will be responsible for paying it every month for the next 360 months, so you better be comfortable with it, regardless of what the lender tells you can afford.

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