How Much Can I Afford?
Every loan product except one has certain qualifying ratios that are required. These ratios help determine whether or not you are capable of paying back the loan over a long period of time, even if you have shown the capacity to pay your bills in the past. There are two qualifying ratios that are often used. The first is known as the “Housing Ratio”, “Front Ratio” or “Credit Ratio”. The second ratio, which is used on nearly all loan programs, is called the “Back Ratio” or “Debt Ratio”. On our website under the loan programs section you can find these ratios listed. Below are how these formulas are calculated.
Credit Ratio = (Principal + Interest + Taxes + Insurance) / Gross Monthly Income
Debt Ratio = (Principal + Interest + Taxes + Insurance + Monthly debt obligations) / Gross Monthly Income
All of these figures are for a monthly basis. If your you pay your home owner’s or hazard insurance policy annually, then divide by 12 to get your monthly insurance figure. Principal, Interest, Taxes and Insurance together have an acronym used in the business you might hear. It is called PITI. Many of the above listed mortgage vocabulary is listed in our Mortgage Definitions section.
Ratios
- Conventional loans will generally allow you a Credit Ratio of 28% and a Debt Ratio of 36-38%
- FHA and Rural Development loans will generally allow a credit ratio of 29% and a Debt Ratio of 41%.
- Sub-prime and Alt-A loans generally have a Debt Ratio only. It generally is 45%, but can go as high as 50% for some lenders.
- Jumbo ARMS, and Pay Option ARMS generally use the conventional ratios of 28% for Credit Ratio and 36-38% for Debt ratio. On ARM loans, underwriters generally don’t use the initial payment as the calculation figure; they use what is called the fully indexed rate calculation. See Below:
Fully Indexed Rate = Loan Index Rate + Loan Margin
To further explain this:
- Loan Index Rate (Index) is the current interest rate for the appropriate readily known measuring tool used for calculating your interest. Some of the common indexes are one year US treasury, LIBOR (London Inter-Bank Offering Rate), Fed Cost of Funds Index (COFI), Prime Rate (used mostly in commercial loans), and Cost of Savings Index (COSI). Many of these can be found in the Wall Street Journal or at www.Bankrate.com.
- Loan Margin is the amount over the Index Rate you will pay. This amount is generally 2.25% - 3.25% above the Index. Sub-prime loans can run 5.75% - 6.75% above the Index and this is where people have a problem.
Two Caveats on Ratios.
- These ratios are exceeded often times by Fannie Mae’s and Freddie Mac’s automated underwriting approval systems (AUS) called Desktop Underwriter (DU) for Fannie Mae, and Freddie Mac’s Loan Prospector (LP). Note: I have seen ratios exceed 100%.
- Other factors such as credit rating, job history, potential for increases in salary, liquid cash or securities available after closing all play a part in these decisions. Note: This is why it is good to get pre-qualified with a mortgage lender prior to looking for a house.
MCA offers a product to protect you against potential mortgage fraud and over-charging. It is called the Consumer Protection Plan. A Mortgage Professional will review your initial mortgage disclosure documentation and when the loan is ready to close the MCA professional will also review your closing settlement documents to make sure you received the correct program, rate and fees as initially disclosed.
