You can make your qualifying ratios look better

For many (but not all) loans, lenders judge your borrowing power through their use of two qualifying ratios: the housing cost (front) ratio, and the total debt (back) ratio. Both the housing cost ratio and the total debt ratio give lenders a way to measure whether your income looks like it's large enough to cover your mortgage payments, monthly debts, and other living expenses (see examples below).

Run-of-the-mill loan reps will merely plug your financial data into their AU program. Savvy loan reps will do a "first review" and then, if desirable, suggest ways to improve your financial profile. The average loan rep approves or rejects. The savvy loan rep says, "Here's what you can do to make your ratios look better."

Calculating the Ratios

With the use of AU (automated underwriting), most loan reps no longer calculate ratios per se. Nevertheless, qualifying ratios matter a great deal. Only now, the math is hidden in the underwriting software program.

If you reduce your qualifying ratios, you raise the odds for loan approval and increase the amount the lender will loan you. Low ratios may also slice your interest rate and mortgage insurance premiums (if any).

Housing Cost (Front) Ratio

Figure your housing cost ratio with this equation:

Monthly gross income where: P&I represents principal and interest (the basic monthly mortgage payment). T&I represents the amount you pay monthly for property taxes and property insurance.

MI represents the monthly mortgage insurance premium you may have to pay if you put less than 20 percent down.

HOA represents the monthly amount you may have to pay to a condominium or subdivision homeowners association.

To keep things simple, say that your household income equals $7,000 per month. You need a loan of $235,000 to buy the property you want. You prefer a 30-year, fixed-rate loan, which (based partly on your credit score) is available at 7 percent interest. This loan will cost $1,563 per month (235 x $6.65). See Table 2.1. Property taxes and insurance on this property total $400 per month. No mortgage insurance applies, but you must pay the homeowners association $125 per month to maintain the community

Table 2.1 Monthly Mortgage Payment for Each $1,000

Borrowed at a Variety of Interest Rates and Terms

Table 2.1 Monthly Mortgage Payment for Each $1,000

Borrowed at a Variety of Interest Rates and Terms

Qualifying Interest Rate

15-Year

30-Year

40-Year

4.0

$7.40

$4.77

$4.17

4.5

7.65

5.07

4.50

5.0

7.91

5.37

4.82

5.5

8.17

5.67

5.16

6.0

8.44

6.00

5.50

6.5

8.71

6.32

5.85

7.0

8.99

6.65

6.21

7.5

9.27

6.99

6.58

8.0

9.56

7.34

6.95

8.5

9.85

7.69

7.33

9.0

10.16

8.05

7.71

9.5

10.45

8.41

8.10

10.0

10.75

8.78

8.50

10.5

11.06

9.15

8.89

11.0

11.37

9.53

9.25

11.5

11.69

9.91

9.68

12.0

12.01

10.29

10.08

12.5

12.33

10.68

10.49

swimming pool, tennis courts, and clubhouse. Here's how to calculate the housing cost ratio for this example:

Housing cost ratio = -

Because the lender with whom you are talking has set a housing cost guideline ratio of 28 percent, your numbers look reasonable. Next we figure the total debt ratio.

Total Debt Ratio

The total debt ratio includes housing costs plus your monthly payments for your installments (such as auto loans) and revolving (credit cards, department store accounts, and so on) debt. At present, your BMW hits you for a payment of $650 a month; the Impala adds in $280. Your credit card and department store balances total $8,000 and require a minimum payment of 5 percent of the outstanding balance per month ($400). Here are the figures:

Housing costs + installment debt + revolving debt Total debt ratio Monthly gross income _ $2,088 + 650 + 250 + 400 = $7,000

With this loan program, the lender prefers a total debt ratio or 40 percent or less. Whoops. Looks like you've blown through this ratio. But does this mean you won't get the loan? Will you have to settle for a smaller amount? Not necessarily.

If your credit score (see Chapter 5) looks strong, your loan may gain approval. If that possibility fails, lift your qualifying income, reduce your monthly payments, or talk up your compensating factors.

(Note: In the easy-qualifying loan markets that prevailed from 2000 until early 2007, lenders would often approve total debt ratios of45, 50, or in some cases 55 percent. Currently, in the face of increasing foreclosures, some lenders are tightening their qualifying standards. Yet, no matter where a maximum debt ratio sits, you strengthen your borrower profile and increase your ability to negotiate approval, interest rate, and costs when you reduce your debt ratios to the lowest percentage possible.)

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Responses

  • daniel
    How to make your ratios better for mortgage?
    7 years ago

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