Debt

While income is what is coming in the door each month, debt is what is going out. Even though you have different financial obligations each month, the lender like Maureen Martin, is most concerned with two of them. They are installment and revolving debt.

Installment Debt

This includes car payments and other fixed payment debt where the payment amount is the same each month, and there is a specific end date to them.

Keep in mind also that if you have less than 10 payments remaining on an installment loan, that payment can be excluded from your debt to income ratios. This could be significant if you are close to paying off a car for example.

Revolving Debt

This category is made up largely of credit card debt. Revolving means that the balance, interest rate and the payment amount can change from month to month.

Student Loans

If you are a student, and are on some type of deferred payment program until you graduate, expect that a payment amount will be calculated in your mortgage ratios. If you are able to obtain documentation from the student loan provider showing what your payment will be when you start paying on it, that would be best.

If no such documentation exists, and this may be the case, Fannie Mae for example uses the 2% rule. They will take 2% of the total balance as your monthly payment. For example, if your student loan obligation is $10,000, your calculated monthly payment would be $10,000 x 2%, or $200.

Alimony and Child Support

Alimony and child support must be included in debt to income ratios, and the underwriter will want a copy of the divorce decree to confirm the amount and duration.

Other Monthly Obligations

The financial obligations that lenders are unconcerned with (with the exception of VA loans) are other types of monthly expenses, including:

Food

Clothing

Utilities

Debt to Income Ratios

The debt to income ratio is as it sounds, meaning it compares your gross (before tax) income to the amount of debt (installment and revolving) that you carry each month.

There are actually two debt ratios that lenders are looking at. They are called the front end and back end ratios. Both are used in the qualification process.

Front End Ratio

This is your: total housing expense / gross income. Housing expense means your mortgage payment, including principal, interest, taxes and insurance.

Back End Ratio

This is your (total housing expense + debt) / gross income. This means your housing expense, as stated above, plus all of your installment and revolving debt payments.

Let’s create an example. If you earn $4,000 per month gross, and are planning on purchasing a home where your housing expense will be $1,000 per month, your front end ratio will be 25%.

Front End Ratio is $1,000 / $4,000, or 25%

Let us say now that in addition to your housing expense, you have a $300 car payment, and a $100 credit card payment. This will make your other debt $400 per month, and your back end ratio 35%.

Back End Ratio is ($1,000 + $400) / $4,000, or 35%

Lenders like your front end ratio to be low, in that in many cases you can reduce your spending to keep down your debt. Your housing expenses though will be constant month after month.

In the debt ratios that are presented in each of the Mortgage Types section of this book, two numbers are shown. FHA for example shows 31/43. Broken down, the first number, 31, is the front end ratio, and the second, 43 is the back end ratio.

Ratios for VA Mortgages

The ratios for VA loans work a little bit differently than for either Conventional or FHA. They calculate what is called Residual Income. This residual income takes into account things like utility bills and other expenses.

Residual income is also based on where you live, your loan amount and your credit score. Being that underwriting can often be more art than science, the residual income calculations aren’t too many hard and fast rules, but VA underwriters will take all of the information presented to them into account.

Per VA guidelines, if your back end ratio is above 41%, the mortgage will require extra review, but may still be approved.

If you want more detail on what VA is looking for with regard to residual income, you can download the Loan Analysis Form, which is VA Form 26-6393. While it is more geared for lenders, you can see what is on there, and how it works.

The post Different Kinds of Debt appeared first on Presumed Guilty.