May 24th, 2020 11:02 AM by Jackie A. Graves
When applying for a mortgage to start the process of an
approval, one of the most important things the lender will look at is whether
or not you can afford the monthly payments should the loan request be approved.
That certainly makes sense but prior to the Consumer Financial Protection
Bureau, or CFPB, requiring lenders to determine affordability, some loan
programs disregarded income altogether. Affordability wasn’t an issue because
income wasn’t verified. That of course all changed when the CFPB implemented
the Ability to Repay rule. This ATR required lenders to calculate monthly debt
and compare it to gross monthly income to arrive at proper debt ratios.
The mortgage payment used for this calculation includes not just
the principal and interest payment to the lender but also a monthly amount for
property taxes, homeowner’s insurance and mortgage insurance when needed. This
monthly total is compared to gross monthly income to arrive at the “front” or
“housing” ratio. In addition, other monthly credit obligations are added to
that amount to arrive at the “back” or “total” ratio. Yet some types of credit
payments are viewed differently.
Payments such as credit card debt, student loans and car loans
and others either fall into the installment category or revolving. When
calculating the back ratio, both can be treated differently. Installment debt
is like an auto loan. Installment debt means monthly payments are fixed over a
predetermined period of time. For instance, an auto loan might be $500 over 60
months. That’s easy enough to figure when calculating debt ratios. Further,
when there are less than 10 months remaining, lenders ignore the payment
knowing it will soon vanish.
Revolving debt can be a credit card or a line of credit.
Revolving debt considers the interest rate on the loan and the outstanding
balance. If there’s a credit card payment listed on a credit report, there will
be a minimum payment amount. Borrowers can pay that minimum payment, a little
more or pay off the balance altogether. The minimum monthly payment will vary
based upon the current loan balance when the credit report was pulled. The
monthly payments will then rise and fall over time. Lenders will use the
minimum monthly payment that appears on a credit report.
Are these debt ratios firm? For most mortgage programs, they’re
essentially guidelines, not hard and fast rules. When a lender runs an
application through an automated underwriting system for a selected loan,
ratios are reviewed as part of the approval process. If a loan program requires
debt ratios not exceed 50, an approval won’t be issued. A 50 debt ratio means
monthly payments add up to half of the applicant’s gross monthly income. Higher
allowable debt ratios are the product of other positive aspects in the loan
file such as higher credit scores or a larger down payment.
Finally, we should take a quick look at lease payments. Again,
let’s look at a car payment. Instead of an outright purchase, the consumer opts
for a lease. When leasing, the borrower doesn’t own the car, but makes regular
monthly payments to the lender for a specified period of time. These payments
are typically fixed, like an installment loan, but at the end of the lease
period the car is returned. An auto lease might be for 48 months, for example.
But unlike an installment loan when there are 10 months remaining, lenders
still count this debt knowing the borrower will have to either purchase the car
outright or return the vehicle and buy or lease another one.
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