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Qualifying ratios

Filed Under mortgage 

Ratios used to determine whether a borrower can qualify for a mortgage. They are based on a borrowers housing expense as a percentage of income and his total debt as a percentage of income.

Debt to Income Ratio or DTI can be improved by paying down liabilities with high monthly payments compared to the balance on the account. In some cases some of your debts can be excluded from the calculation of your DTI. For example if you have an auto loan and you have less than 10 payments left you can exclude this monthly payment from the calculation thus reducing your DTI.

There are several loan types that can help you if you have a high debt ratio with good credit. One is called a No Ratio loan: The Borrower’s source of income is verified, but the income amount is neither disclosed nor verified. The second type of loan is called No Income No Asset: The Borrower’s employment, income, or assets are not disclosed or verified. A third type of loan usually associated with FHA is the Streamline loan: No income documentation or disclosure is required.

When evaluating your Debt-to-Income ratio, the Back DTI plays a more important role than the Front DTI. The Front DTI is calculated by dividing the proposed housing expenses, also referred to as PITI, by the borrowers’ total gross income. Housing expenses or PITI is defined as the inevitable expenses incurred as a direct result of owning the subject property, such as mortgage payment, property tax, hazard insurance, (hence the acronym for Principal, Interest, Taxes, and Insurance), homeowner association dues, private mortgage insurance, etc. The Back DTI is calculated by dividing the borrowers’ total monthly obligations by the total gross monthly income. Total monthly obligations includes not only the housing expenses, but also all installment debt payments such as leased/financed vehicle and credit card payments. Most lender banks would allow a borrower’s Front DTI ratio to go above 45% if the borrower has no other obligations.

Qualifying ratios also called your debit to income ratios or debt load consist of your total verifiable gross monthly income divided by your new proposed payment, all your other monthly debits such as minimum payments on charge cards, auto loan or lease payments, student loans, consumer loans, child support and alimony.

A debt to income ratio is simply a way of determining how much money is available for your monthly mortgage payment after all your other recurring debt obligations are met. Qualifying ratios are guidelines, an excellent credit history can help you qualify for a mortgage loan even if your debt load is over and above the limit. Typically conventional loans have a qualifying ratio of 28/36. Usually an FHA loan will allow for a higher debt load, reflected in a higher (29/41) qualifying ratio. The first number in a qualifying ratio is the maximum percentage of your gross monthly income that can be applied to housing (including loan principal and interest, private mortgage insurance, hazard insurance, property taxes and homeowner’s association dues). The second number is the maximum percentage of your gross monthly income that can be applied to housing expenses and recurring debt. Recurring debt includes things like car loans, child support and monthly credit card payments.

Not all monthly debts/liabilities have to be taken into consideration when determining the amount of a borrower’s recurring monthly debt obligations. Such liabilities are known as contingent liabilities. Some of the most common that may be exempt under certain circumstances are co-signed loans, court-ordered assignment of debt, and loans secured by financial assets

Many mortgage lenders have thrown those old ratios out the window, approving household debt ratios in excess of 50% of income. If over 50% of your income is going to debt service you will be forced to either live a very shallow life with little or no funds for saving, investment or enjoyment, or, worse, are headed for a financial disaster.

Qualifying ratios are only a rough guidelines and underwriters consider many variables in their analysis. Many times, borrowers fall outside the guidelines, but have strong compensating factors that reflect low credit risk. Some compensating factors are history of savings, long-term job stability, a substantial down payment or excellent credit history will influence the decision to approve or deny a particular loan.

There are loan programs such as No Ratio and No Doc, that will basically avoid the debt ratio calculation for you. The only one that can make this decision, is the borrower. They are the person that will have to make the payments, with or without the calculation.

Automated underwriting can also bypass the typical qualifying ratios. Automated underwriting takes into consideration credit and assets and can give approvals for debt ratios or 50,60,or 70% or more.

The front-end ratio, or front ratio, compares your monthly pre-tax income with your house payment. The other ratio that lenders look at is the back-end ratio, or back ratio. This calculates how much of your pre-tax income will payments— such as auto loans, credit cards, go toward your house payment, plus all of your other monthly debt etc. It can be useful to figure out these numbers yourself and see if the house payment you have in mind may actually cause you undue financial risk.

Many times on a refinance loan the way to lower your ratios is to pay off debt at the time of the refinance, this reduces your monthly payments and in turn, your ratios.

Some lenders are stricter about qualifying ratios than others. Just being within the lender’s debt to income ratio limits is only one aspect of qualifying for a home loan. Most lenders will consider the overall financial picture. If everything looks good, a lender may allow you to carry more debt. When shopping for a new home, it is always wise to be pre-approved, so that you’ll know specifically what price range and loan payment fits your budget. Remember to be Pre-Approved, Pre-Qualified is just not enough.

How much house can you afford? That’s what lenders want to know when making their decisions about your mortgage. If you are having trouble qualifying for a loan program because of your ratios, contact us and ask about extending the term or discussing a temporary buy down to help you qualify.

Qualifying ratios can prevent purchasers from obtaining a home however there is an opportunity to use a 40 year mortgage to reduce the payment by extending the term and therefore create a more favorable qualifying ratio calculation.

Many lenders allow debt to income ratios to go as high as 55%. Meaning the new mortgage payments plus all existing monthly liabilities can be as high as 55% of the borrowers total gross income.

On conforming loans, you can still usually get an approval even if your debt ratios are higher than the set standards. Low loan to value ratios and lots of reserves can offset higher debt to income ratios.

Although your ratios may be high you can still qualify for alternative programs with higher ratios. For the most part a lender will look at what’s reported on your credit report to determine your ratios. The best thing for you to do is consult a Professional Mortgage Broker and have them look at your credit to see where your ratios are and what you qualify for. And remember that safe secure online forms from a Mortgage Website is the fastest way to achieve this.

Is your rate too high? If you're looking to compare mortgage rates or to get a rate quote on a FHA loan start here


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