Primary marketThe Scoop On Qualifying Ratios
Question: My wife and I are looking at the possibility of buying a new home in Fairfax County, Virginia. It appears that the house we like will cost close to $850,000 if we include the upgrades we want. The builder"s mortgage company sent us a Good Faith Estimate using an 80-10-10 arrangement. The first trust is a 5/1 ARM with a five percent interest rate and a second trust of 5.375 percent. The total monthly payment will be around $4,800. We have enough cash to cover the 10 percent down payment and closing costs.
Our current combined income is $113,000. Based on what I have read about qualifying ratios it seems that we may not qualify for the loan, although we are comfortable with the payment. We don"t have any other debt. My question is this: Are there lenders out there who allow higher ratios to those who have good credit and other positive factors? Also, what can be done to improve our ratios?
Answer: Definitely good questions. Let"s start from the beginning. First let me start by explaining "qualifying ratios." Lenders look at three basic criteria when underwriting a loan applicant:
Credit history
Collateral and amount of down payment
Ability to repay the loan
The first is obvious. If you have a history of not paying your bills responsibly, a lender will be reluctant to make you a loan. The second criterion involves risk to the lender. If you put down a large some of money as a down payment, lenders are more likely to be more flexible in underwriting. A larger down payment means the collateral that secures the loan is worth more than the loan amount itself.
The last thing an underwriter will look at is the borrower"s ability to repay the loan. The bank wants to make sure you have enough income to support the mortgage payment. Herein lies your problem. Let"s take a look.
A salary of $113,000 equates to $9,416 per month, before withholdings. As a general rule of thumb, lenders don"t like to see your total mortgage payment exceed 33 percent of your gross monthly income. This ratio is called the "house-to-income" ratio, or more commonly known as the "front" ratio. Using a maximum ratio of 33 percent, your front ratio would be $3,107. Clearly, this "maximum allowable payment" is a lot less than your proposed payment of $4,800.
The second ratio, known as the "total debt-to-income" or "back" ratio, takes the new proposed housing payment and adds all other monthly debt. These would be items such as personal loans, car loans, and the minimum required payment on credit cards. The back ratio does not include things such as utility bills or a child"s school tuition or orthodontic bills.
What"s the rule of thumb for a maximum "back" ratio? Thirty-eight percent. Thirty-eight percent of your gross monthly income is equal to $3,578. Your proposed total house payment of $4,800 is equal to 51 percent of your gross monthly income. Ouch.
The 33/38 numbers for front and back ratios are indeed only a guideline. Lenders will allow much higher ratios if the application, analyzed in the big picture, makes sense. Fifty-one percent with only 10 percent down, however, might be tough to get through. When you think about it, it makes sense. If you gross $9,416 per month, your take home pay, after tax withholdings, etc. is perhaps $6,500 or less. After you make your monthly mortgage payment of $4,800, you"re left with only $1,700 to pay your living expenses -- utilities, groceries, auto, gas, entertainment, etc. There"s not a lot left over.
But lets now answer your questions specifically. Yes, there are lenders who offer mortgage programs that will accommodate your situation. Inquire about a "no income verification" loan. These programs underwrite on the basis of credit and down payment, not income. Expect to pay a higher rate.
In addressing your second question, there are ways to improve your qualifying ratios, aside from borrowing less money. Ask about an ARM with an interest-only payment option. This program allows your minimum payment to cover only the interest charged each month. My calculator tells me that your payment would drop by more than $750 per month.
Before jumping on this house, though, I would advise you to double-check your household budget and make certain that $4,800 per month is truly affordable. If not, consider an interest-only ARM or lower your sites and search for another house.