Debt-to-income analysis is perhaps the most important factor involved in getting approved for a mortgage loan or loan modification today. So how are your debt-to-income ratios calculated, how can you improve them and what could kill your deal?
Is Your Debt-to-Income Ratio Killing Your Chances of Getting a Loan?
With the extinction of stated income and No Doc home loans, your debt-to-income ratios will not just determine how much house you can buy but whether you can purchase a home or refinance a current loan at all. A few years ago lenders stretched debt-to-income ratios to 55 percent plus. Now you are expected to have maximum debt-to-income ratios of 31/43 in most cases.
This means that your monthly housing payment - including principal, interest, taxes and insurance - shouldn’t exceed 31 percent of your gross monthly household income. Thanks to low home prices and record low mortgage rates, this is now much easier to achieve than ever before. However, where most people struggle is with the “back-end” debt-to-income ratios. This takes into account all of your monthly debt obligations as a percentage of your gross monthly income. This means if you make $5,000 a month, your housing, credit card, car loan and other payments cannot exceed $2,150 per month.
Debt-to-Income Ratios and Loan Modification
Generally, in order to qualify for a loan modification, your current “front end” debt-to-income ratio must exceed 38 percent. Your lender will strive to offer a solution which reduces your housing payment to an amount which will not exceed 31 percent. This can include reducing your interest rate, extending the length of your loan and even forgiving a portion of your principal balance if necessary.
Tips & Tricks for Reducing Your Debt-to-Income Ratio
1. Pay off or pay down your credit card debt, which can also improve credit scores.
2. Pay down installment loans to fewer than 10 months left. Then they won’t be counted in your debt-to-income ratio.
3. Negotiate lower rates or better terms on your other debts to reduce monthly payments.
4. Add a co-borrower to your application for more income.
The Silent Debt-to-Income Assassins That are out to Get You
Unfortunately, most civilians are not aware of some of the items which can kill their debt-to-income analysis.
Watch out for these nasty little assassins:
1. Credit or store cards with zero interest or deferred payment deals will still count against your debt-to-income ratio.
2. Student loans, even those with deferred payments can count against you.
3. For the self-employed it is important to realize lenders will base your income on your adjusted gross income (AGI).
Calculating Debt-to-Income Ratios for the Self-Employed
As highlighted above, it can be incredibly difficult for self-employed individuals - whether business owners or independent contractors - to make their debt-to-income ratios line up. Whereas salaried persons need to simply provide W2s and a pay stub to prove their income, the self-employed must provide 1099s, tax returns, a year-to-date profit and loss statement and business license. If you find this challenging, you are not alone. Even some real estate professionals who have grossed three or four million dollars in a year can find that their adjusted gross income comes in as low as $300,000 after deductions to minimize taxes. If you plan to purchase a new home in the near future, ask a mortgage broker for tips on maximizing your qualifying income and about items like depreciation, which can be added back to your income. Also consider paying yourself a higher salary if you own your own business. If all else fails, ask about alternate loan programs which may accept other forms of income documentation.