Pay Down Debt to Less Than 10 Payments

Loans secured by financial assets, such as a loan against a 401(k) or a savings account, are treated differently. These loans generally do not require consideration of repayment for qualifying purposes if the repayment can be obtained by extinguishing the asset. Therefore, the “pay down” restriction to meet a 10-month window does not apply in the same way, as these debts are often excluded based on the collateralizing asset rather than the remaining term. However, the assets used to secure the loan cannot be counted toward the borrower’s required reserves.

If an installment debt has fewer than 10 months of scheduled payments remaining without any prepayment or manipulation, it may be excluded from your DTI ratio, provided the monthly payment does not exceed the 5 percent income threshold. In this scenario, you do not need to pay down the balance because the term is already within the allowable limit. However, the lender must still verify that the payment amount is not so large that it would significantly affect your ability to meet your monthly housing obligations during those remaining months.

Yes, you can apply the 10-month rule to multiple closed-end debts, provided they meet the cumulative payment criteria. The guidelines specify that the cumulative payments of all such debts being excluded must be less than or equal to 5 percent of your gross monthly income. For example, if you have two small loans that both have 6 months remaining, you can exclude both if their combined monthly payments do not exceed 5 percent of your monthly income. If the total exceeds that percentage, the debts must be included in your DTI.

The FHA prohibits paying down the balance to meet the 10-month requirement to ensure that the borrower’s DTI ratio accurately reflects their ongoing financial obligations and ability to repay. Allowing a borrower to manipulate the remaining term through a lump sum payment could mask affordability issues. The rule ensures that the exclusion of debt is reserved for obligations that are naturally ending and will not burden the borrower for the majority of the first year of the mortgage. It prioritizes a true assessment of the borrower’s standard repayment capacity.

If you pay off an installment debt to qualify for the loan, the lender must verify that the debt is fully satisfied and examine the source of the funds used. You will need to provide evidence such as a credit supplement showing a zero balance or a settlement statement showing the payoff at closing. Crucially, the lender must document that the funds came from an acceptable source, such as your own savings or a valid gift, and that you did not open a new unsecured loan to pay off the existing debt.

The restriction on paying down debt is generally irrelevant for leases because leases are treated differently than 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. You cannot exclude a lease even if it has fewer than 10 months left, so paying it down to reduce the term would not help you qualify. The entire monthly payment is counted because it is assumed the leased item will be replaced with a new obligation.

The 5 percent rule serves as a safeguard for affordability. Even if a debt has fewer than 10 months remaining, if the monthly payment is substantial enough to affect your financial stability, it must be counted. Specifically, if the cumulative monthly payments of all debts you wish to exclude exceed 5 percent of your gross monthly income, they cannot be excluded from your DTI ratio. This prevents borrowers from entering a mortgage with significant short-term cash flow obligations that could jeopardize their ability to make their new housing payments.

Yes, while paying down a balance to meet the 10-month rule is restricted, paying off an installment debt in full prior to or at closing is permitted. If you choose to eliminate the debt to improve your DTI, the account must be paid in full. The lender will require documentation, such as a payoff statement or a Closing Disclosure reflecting the payment. Additionally, you must verify that the funds used for the payoff came from an acceptable source and that no new debts were incurred to satisfy the old obligation.

To exclude a closed-end debt, such as an installment loan, from your DTI ratio, two conditions must typically be met. First, the debt must have fewer than 10 months of scheduled payments remaining. Second, the cumulative monthly payments of all such debts being excluded must be less than or equal to 5 percent of your gross monthly income. If the combined payments exceed this 5 percent income threshold, the debts must be included in your qualifying ratio regardless of the short time remaining on the accounts. This ensures the payments won’t impact your ability to pay the mortgage.

No, FHA guidelines explicitly prohibit borrowers from paying down the principal balance of a loan solely to meet the 10-month requirement for exclusion from the debt-to-income (DTI) ratio. The remaining term of the debt must be the result of the natural payment schedule rather than a prepayment made specifically to qualify for the mortgage. If you make a partial payment to bring the remaining installments to fewer than ten, the lender is still required to include that monthly payment in your qualifying ratios, as this manipulation of the debt term is not permitted.