When you apply for a mortgage, a loan from a relative is treated like any other debt such as a credit card or car, student or personal loan. The monthly loan payment you make to your relative is included in your debt-to-income ratio which impacts the mortgage you qualify for.
Your debt-to-income ratio is basically the sum of all of your monthly debt payments including your mortgage, property tax and homeowners insurance, relative to your monthly gross income. In short, lenders permit you to spend only so much of your income on monthly debt expense. The debt-to-income ratio for a mortgage typically ranges from 40% to 50% depending on the lender, loan program and other factors.
For example, if your monthly payment on the loan is $200, the lender includes $200 in your total monthly debt expense to calculate the mortgage you are eligible for. The higher your debt expense, the lower the mortgage you can afford. On the other hand, lower monthly debt payments enable you to spend more money on your mortgage and increase the loan you qualify for.
In some cases a loan from a relative reduces your mortgage amount while in other cases it may increase your mortgage. It all depends on how you spend the proceeds from the loan.
If you use the loan to pay off or pay down a debt with a high interest rate, you may be able to qualify for a higher mortgage amount. For example, if you receive a $10,000 loan from a relative with a 5% interest rate and use the proceeds to pay off a credit card account with a 15% rate you significantly reduce your total monthly debt expense.
Reducing your debt payments improves your debt-to-income ratio and boosts the mortgage you can afford. In this case, the loan from a relative helps your mortgage application.
Use ourMORTGAGE QUALIFICATION CALCULATORto determine the mortgage you can afford based on your monthly gross income and debt expense
If you used the loan proceeds for something other than to pay down high cost debt -- such as buying a car -- the mortgage you can afford goes down. In this scenario, the loan payment is simply added to your other debt expenses -- which remain the same -- causing your debt-to-income ratio to increase and reducing the mortgage you qualify for.
Please note that when you submit your mortgage application you should provide a brief summary that outlines the key terms of the loan including the original loan amount, current balance, monthly payment, interest rate and the length of the loan. It may also be helpful to keep a paper trail such as bank statements or cancelled checks that document any loan payments you have made.
Additionally, if you use the proceeds from the loan to pay off a debt make sure to obtain an updated account statement from the creditor that reflects your new balance. It can take several months for your credit report to update and you want to benefit from your lower debt expense when you apply for the mortgage.
The final point to highlight is that payments you make on a loan from a relative and the loan itself are not reflected on your credit report. So making your payments on-time and reducing your loan balance does not improve your credit score like it may with another type of loan.
That said, if you use the proceeds to pay off other debt and to lower your credit utilization rate, this can have a positive affect on your credit score, although it can take multiple months for your score to increase. For many mortgage programs, having a higher credit score enables you to qualify for better loan terms including a lower mortgage rate.
In closing, there are cases when a loan from a relative can improve your ability to qualify for a mortgage or enable you to afford a higher mortgage amount. In other cases, the loan may make it more challenging to get approved for the mortgage you want. Before you take out any new debt it is important to consider how you are going to use the proceeds and how the loan affects your debt-to-income ratio.
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"B3-6-02, Debt-to-Income Ratios." Selling Guide: Fannie Mae Single Family. Fannie Mae, February 5 2020. Web.« Return to Q&A Home About the author