Qualifying for a home loan is sometimes tough, but qualifying for a second home loan is often a nightmare. A mortgage payment is the largest debt carried by most homeowners. A second mortgage is a big risk, not just for the borrower, but for the lender as well. To make sure a potential borrowers qualify, the lender looks closely at their debt-to-income ratios.
Your debt-to-income ratio is a number that shows the total percentage of your income that is allotted to paying your bills. The lender uses your credit report, pay stubs, W-2 forms and tax returns to calculate the ratio. The threshold varies by lender, but typically, you want no more than 36 to 40 percent of your monthly income going toward your monthly debt. If your ratio is higher than 40 percent, you'll generally have a difficult time qualifying for the loan.
When you fill out your loan application, you sign a form giving the lender authorization to run your credit report. The lender will tally up your monthly payments based on the information in the report. This figure includes your monthly mortgage, auto payments, credit cards, student loans and personal loans. It does not include insurance, utilities or taxes. While these payments won’t affect your loan approval, don’t discount them as they could affect your ability to carry the debt. Once it calculates the total, the lender adds the payment for the proposed mortgage to your total debt -- including your first mortgage.
Lenders require that you submit documents to prove your income. Common documents requested include pay stubs, W-2 forms and tax returns. Other less common, documents may include 1099s or brokerage statements. If you have any income that you don’t report, such as tips or under-the-table payments, you can’t include them in the ratio. The lender calculates your gross monthly income before taxes or other deductions. It then divides your total monthly debt by your total monthly income. The result is your debt-to-income ratio.
While debt-to-income ratio is a good indication of your ability to repay, a slightly elevated number won’t necessarily discount you. The lender might make an exception to its policy if you have compensating factors, also known as mitigants. For example, while you might have a 41 percent debt-to-income ratio, your loan-to-value ratio with two mortgages might be low -- meaning your house is worth significantly more than the total of your mortgages. Another example is a case where your debt-to-income ratio is high, but you have a large deposit relationship with the lender. In these cases, the lender might make exceptions because the compensating factors mitigate the risks.