I recently received an email from a past client that got me scratching my head. Here is the email (with identifying information removed to protect the innocent and so as not to divulge protected client information…):
I just wanted to let you know my current situation so that you can use it as a warning to any of your current or future clients.
I have been house hunting lately and went through the process for qualifying for a loan. I ended up getting turned down because the banks limit the amount of debt to 43% of gross income. It turns out that even though the alimony payment I make to [my ex] is not considered income for tax purposes, the banks consider it as debt. In my case, the alimony comprises about 40% of my gross income which leaves too little room for a mortgage.
I’m bringing this up to you because in retrospect, it would have been better as the paying spouse if I had negotiated to retain the house. Hopefully this information will help you when guiding the decisions of your clients during their separation process.
The main issue brought up here is whether alimony is considered a “debt” in the eyes of the mortgage lender, or whether alimony is a reduction in income.
Alimony as a debt vs. reduction in income
Let’s say the paying spouse, John Doe, makes $120,000 per year, or $10,000 per month. Mr. Doe pays $3,500 per month in alimony, and he is considering purchasing a residence that would require a mortgage payment of $1,200/month. If alimony is considered a debt (and assuming Mr. Doe has approximately $500 in other debt service obligations, such as car payments, loan payments, or credit cards), then Mr. Doe’s total debt service is $3,500 + $500 + $1,200 = $5,200 per month. Accordingly, his back-end debt-to-income ratio would be $5,200/$10,000 = 52%. Depending on the requirements of the lender, this may or may not qualify Mr. Doe for a mortgage.
On the other hand, if the alimony payment is considered a reduction in income, as is the case for certain FHA loans, then Mr. Doe’s income falls to $6,500 per month, and his resulting debt-to-income ratio is now ($500 + $1,200)/$6,500 = 26%, a much more respectable number.
Thinking about buying a house after your divorce?
I recommend that you talk to your divorce lawyer and mortgage broker before you agree to a certain amount of alimony. You want to make sure that you can structure the alimony payment such that you will be able to qualify for the mortgage you need after the divorce is final.
In addition, you may want to consider an FHA loan, which may be more likely to consider alimony as a reduction in income vs. a debt service obligation.