Having a relative payoff a loan for you before you apply for a mortgage offers multiple benefits but there are several points to keep in mind to make sure there are no issues with your loan application.
Paying off a loan reduces your monthly debt expense which positively impacts your debt-to-income ratio. The lower your monthly payments for credit cards as well as car, student and personal loans, the higher the mortgage amount you qualify for.
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Paying off your debt may also increase your credit score, especially if you close the account that is paid off. For example, in some cases reducing your borrowing capacity or credit utilization can boost your score.
Because it can take some time for updated account information to appear on your credit report and impact your score, we recommend that you payoff the loan as soon as possible before you apply for the mortgage. An increase in your credit score may enable you to qualify for a lower mortgage rate and lower your monthly payment.
When your relative pays off the loan, it is important that you keep a record of the transaction such as an updated account statement or other proof of payment. You can provide these documents to the lender when you apply for your mortgage if there are any questions if the loan has been paid off or a delay in your credit report being updated.
Additionally, it is better if the loan is paid off directly by the relative instead of depositing the funds in your bank account first. When you apply for a mortgage, lenders typically request two months of bank statements. If a lender sees a large deposit into, and payment from, your bank account, it may raise some questions with the lender.
The lender may ask if the deposited funds is actually a loan instead what is effectively a gift to pay off debt. If the lender believes that the money your relative provided you is a loan then the lender may include payments for the loan in your debt-to-income ratio, which reduces the benefit of your relative paying off your debt.
In some cases the lender may require your relative to provide a gift letter confirming that the money is not a loan and to provide additional information on the source of the funds provided to you. While this issue should not prevent you from qualifying for a mortgage, your best course of action is usually to have the relative payoff the loan directly as opposed to giving you the funds and you paying off the loan out of your account.
With the proper documentation and right payment approach, having a relative payoff a debt can can both save you money and help you qualify for a mortgage. We recommend that you contact multiple lenders in the table below to understand the mortgage you can afford and to compare loan terms. Shopping multiple lenders is the best way to save money on your mortgage.