Military Housing Allowance and Loan Qualification

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One of the things that is really helping military families afford good properties is the military housing allowance and the way that lenders treat it, making it much easier for them to qualify with regards to debt to income ratio, while the magic bullet of VA loans makes loan to value ratio essentially a non-issue. Between these benefits, the military is sitting pretty for being able to afford housing.

I should mention that this math helps non-military getting a housing allowance just as much, but there are relatively few people outside of the military receiving a housing allowance.

Receiving a housing allowance actually works out far more advantageously for purposes of loan qualification than if they just paid them the extra money. $X basic salary plus $Y housing allowance is demonstrably more money than a salary of $X+Y. Here's how it works.

To start with, the housing allowance is generally non-taxable. I'm sure you know that's not the case with your basic salary. The $Y extra you get in allowance really is $Y, not the much lesser amount that you would get to keep.

On top of that, the housing allowance is "soaked off" against the expenses of housing on a dollar for dollar basis. In other words, compute your cost of housing - principal and interest on the loan, taxes, insurance, Homeowner's Association dues, Mello-Roos, etcetera. Add them all up. From this, subtract housing allowance. If the housing allowance is more than actual cost of housing, we're all done. You made it, at least on the basis of debt to income ratio. If the costs are more than the allowance, all is not lost. At this point, you have to add in other debt service to whatever is left, but then so long as you are less than the normally allowed debt to income ratio as compared to your regular salary, you still qualify. Is this a great country, or what?

Here's a concrete example of how it all works: Let's say you make $3000 per month salary from the military. In addition to that, you get a $2000 housing allowance. You have other monthly debts of $250, and you want to buy a property where the monthly expenses of owning it (principal and interest on sustainable loan, taxes, and insurance, or PITI) are $2500. If you made that $5000 per month as a regular working schmoe, you would be told you aren't likely to qualify. Your "front end" ratio would be 50%, and adding the other monthly debt service makes 55%. Normal guidelines are 45% "back end" (housing plus all other debt service) for conforming loans, and you're way over that on the front end alone. Maybe in some circumstances such as disability or retirement income with a "walks on water" credit score, that might be accepted by one of the automated loan underwriting systems, but under manual underwriting rules you are dead in the water.

As the beneficiary of that housing allowance, however, things are quite different. The $2000 housing allowance draws off housing expense dollar for dollar, not at the 45% ratio of the rest of your salary. Instead of $1 enabling you to have forty-five cents of housing expense, it enables your to have $1. So subtract $2000 housing allowance from $2500 housing expense, and you have $500 left over.

If housing allowance was $2500 against that $2500 housing expense, or to use the general case, if housing expense was less than or equal to housing allowance, we'd be done, at least on the grounds of debt to income ratio. We're not done yet in this case, but the remaining $500 of housing expense plus $250 of other debt service equals $750, which divided by $3000 regular income yields a 25% back end ratio. Since this is less than 45%, bing! Debt to Income ratio works - by which I mean that you are over the most important hurdle in loan qualification.

So there you have an example where somebody making exactly the same number of dollars does not qualify where someone getting part of their salary via a housing allowance does. Since the military is pretty much the only folks that get paid that way (I can't remember the last time I had anyone not in the military with a housing allowance) , advantage: military.

A couple of caveats need to be mentioned and emphasized right now. As should be obvious to the mathematically inclined, Comparatively small amounts of difference make much larger differences to debt to income ratio. Change the PITI payment to $3000, and your debt to income ratio stands at 40 percent, getting close to the ultimate edge of qualification.

You should also be careful that you really can make the payment on the loan. Foreclosure is no fun, as millions can attest right now. Make certain you really can make the payment, considering your family's lifestyle and other bills that may not be monthly debt but would be difficult to eliminate. I have written multiple times warning Never Choose A Loan (or a Property) Based Upon Payment.

Because I am normally careful to quote in terms of purchase price and loan amount and interest rate, I want to say why I did it this way, quoting in terms of payment, in this case. It's a complex subject, and the math gets hairy very quickly, and varies constantly and from market to market and time to time as interest rates and home prices change. Judging by my traffic, people are going to be reading this article months from now, if not years. I wanted a concrete, easily understood example of the subject that's not going to be completely out of line six months from now when the rates have changed and some housing markets are recovering strongly while others are still in the process of crashing.

I also should observe that companies looking to help their employees while conserving costs can do this every bit as much as the military does by carving off a portion of the salary and paying it in the form of housing allowance - but in order to do that, they'd have to admit these people were employees. Pay the social security taxes lots of companies are manipulating the law to avoid, give them all the rights contractors don't have in employment. Of course, the reason why that happens is due to government action. Every time the legislature or some judge adds another cost to having employees or makes it more difficult to terminate those who need to be terminated, they give corporations another reason to avoid hiring them in the first place.

Caveat Emptor

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This page contains a single entry by Dan Melson published on February 4, 2009 7:00 AM.

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