Excluded closed end debts

If a debt is revealed during the application process that was not listed on the credit report (such as a new installment loan), the lender must verify the actual monthly payment and the terms of the loan. This debt must generally be included in the borrower’s liabilities. To be excluded, it would need to meet the same strict criteria: the lender would have to verify that it has fewer than 10 months remaining and that the payment is less than 5 percent of gross income. Additionally, the lender must verify that the borrowed funds were not used for the down payment.

The lender will primarily rely on the credit report to determine the remaining term and the monthly payment amount for the installment debt. If the credit report does not reflect a monthly payment, or if the reported payment amount is different from what is stated in the loan agreement, the lender will use the actual loan agreement or a current payment statement to document the correct amount. If the credit report confirms there are fewer than 10 months remaining and the payment is low enough, no further documentation is typically needed to exclude it.

Yes, the specific criteria regarding the 10-month term and the 5 percent income threshold are explicitly outlined for manually underwritten loans. For these loans, the underwriter must rigorously check that the cumulative payments of excluded debts do not exceed the income percentage. This ensures that borrowers who require manual underwriting—often due to credit issues or higher risk factors—are not approved for a mortgage payment that might be unaffordable when combined with their other short-term debt obligations.

Loans that are secured by financial assets, such as a loan taken out against a 401(k) account or a savings account, are effectively excluded from the DTI calculation but under different criteria. These loans do not need to be included in the qualifying ratio if repayment can be obtained by extinguishing the asset (using the deposited funds to pay it off). However, the asset securing the loan cannot be counted toward the borrower’s required reserves or cash to close. This is a distinct exclusion separate from the 10-month rule applied to unsecured or vehicle loans.

If a closed-end debt has fewer than 10 months remaining but constitutes a significant portion of your budget—specifically, if it exceeds 5 percent of your gross monthly income—it must be included in your debt ratios. The underwriter is required to consider the impact of the debt on your ability to meet your monthly obligations. Even with a short term remaining, a high monthly payment can cause “payment shock” or financial distress, so the guidelines require these debts to be counted against the DTI to ensure affordability during the initial period of the new mortgage.

Generally, no. Auto lease payments are treated differently than standard closed-end installment loans. FHA guidelines state that lease payments must be included in the borrower’s recurring monthly debt obligations regardless of the number of months remaining on the lease. The rationale is that a lease represents a long-term lifestyle cost, and it is assumed the borrower will obtain a new lease or purchase a new vehicle once the current lease expires. Therefore, the payment is viewed as a continuing obligation rather than one that will disappear in the short term.

No, the rule applies to the cumulative total of all closed-end debts you wish to exclude. For example, if you have a car loan and a personal loan that both have fewer than 10 months remaining, the underwriter will add both monthly payments together. If this combined total exceeds 5 percent of your gross monthly income, neither debt can be excluded from your qualifying ratio. This rule ensures that a borrower does not face a significant cash flow shortage during the early months of the new mortgage due to multiple expiring debts.

While paying down a balance to meet the exclusion rule is prohibited, paying off an installment debt in full prior to or at closing is permitted. If you choose this route, the lender must document that the debt has been satisfied. Additionally, the lender must verify the source of the funds used to pay off the debt to ensure they come from an acceptable source. It is critical that the borrower did not incur new debts to pay off the old ones, as any new obligations would then need to be included in the DTI ratio.

No, FHA guidelines explicitly prohibit borrowers from “paying down” a loan balance solely to meet the 10-month requirement for exclusion. The remaining term of the loan must be the result of the natural amortization schedule of the debt. You cannot make a partial prepayment to reduce the remaining payments to 9 months just to qualify for the mortgage. If you need to remove the debt liability to qualify for the loan, you generally must pay off the account balance in full rather than simply reducing it to a lower number of remaining months.

To exclude a closed-end debt, such as an installment loan, from the Debt-to-Income (DTI) ratio, two specific conditions must be met simultaneously. First, the debt must have fewer than 10 months of scheduled payments remaining calculated from the date of the loan closing. Second, the cumulative monthly payments of all such debts being excluded must be less than or equal to 5 percent of the borrower’s gross monthly income. If the payments exceed this 5 percent threshold, the debt must be included in the qualifying ratio regardless of how few months remain on the loan term.