Home Loan Housing Ratios
Mortgage lending institutions use several gauges to measure how much of a mortgage you can afford. Housing ratios is one such gauge that measures your capacity to deal with the monthly mortgage payment. These ratios are used to evaluate mortgage loans for home purchases and existing mortgage refinances.
Housing ratios are generally broken down into two distinct measures or ratios. The first housing ratio often referred to as the front-end ratio, measures the cost of your mortgage payment divided by your gross monthly income. The second ratio, referred to as the back end ratio, measures your mortgage payment with all other contractual monthly payments divided by your gross monthly income. Some banks and mortgage lenders separate the term housing ratio to mean just the house payment and the debt ratio to refer to all payments.
The front end ratio calculates the full PITI mortgage payment. The PITI is the principal and interest payment of the home loan, the monthly real estate taxes and monthly cost of homeowners insurance and/or mortgage insurance. The back end ratio adds to the PITI any other contractual debt. Examples of other debt would be; car loans, credit card payments, department store charge card payments, personal loans, and similar debt payments. Generally utilities bills and day care expenses are not included in the housing ratios. Also excluded are payments on installment loans the have 10 payments or less remaining.
Housing ratios on conventional mortgage loans are usually 32% for the front end ratio and 38% for the back end ratio. FHA loans are generally expected to be 29% for the front end and not to exceed 43% on the back end ratio. As you can tell from the description, ratios are generally set as guidelines not laws that have to be enforced. One can view the housing ratios as guideposts to which your expenses should not exceed. However, with compensating factors is possible to obtain approval for a home loan with excessive housing ratios.
Compensating factors are generally favorable features about your application they would be considered better or more desirable than the standards credit and income requirements. Examples of compensating factors might include; exceptionally good credit, financial assets above and beyond the necessary amount for the loan request, or a low loan to value ratio. If an FHA applicant had debt ratios of 30% and 45% but was putting a 25% down payment, this loan will most likely get approved rather easily.
The biggest problems in housing or debt ratios, other than an applicant having ratios that exceed the requirements, is the accurate calculation of monthly income. Income in the mortgage industry is measured is the gross or before tax income, calculated on a monthly basis. Part time jobs with less than two years are generally considered as income. Overtime income must be verified that it will continue and must be received for the past two years. All income that fluctuates significantly will usually be averaged over the previous two years.
Debt payments play a big factor in qualifications as well. If a mortgage applicant can reduce there monthly debt payments, it may be easier to get approved for a home loan. Obviously, reducing the debt itself is the clearest method. However, it is also most likely the most difficult. Almost any legitimate plan to reduce an applicant’s debt prior to applying for a home loan is acceptable. In some cases, if the primary borrower makes all the income but has an excessive debt load that ends up disqualifying them for a mortgage loan, there is a trick. Debt that can be pushed on to the spouse that is not cosigned by the primary borrower relieves that debt payment from the primary borrower. Since the spouse’s income is not used to qualify for the mortgage purchase or refinance, it is possible to leave the spouse off the home loan and qualify with the primary borrower with debt transferred onto an account of the non-qualifying spouse.
Housing ratios and debt ratios are general rules. Certain factors regarding qualifying for a loan will be hard and fast rules, not these ratios. These numbers should be a guidepost to give you a reasonable idea as to what you can afford. Be sure to check the mortgage rates when evaluating debt ratios since a higher mortgage rate means a higher mortgage payment and a greater debt ratio. The mortgage calculator can be very helpful for measuring debt ratios and the impact of different mortgage terms and mortgage rates.