The lender divides the PITT by monthly income:
$1,401÷ $6,250 = 22.4%
This ratio is within the 28%* needed to qualify, so the loan looks affordable. Next the lender considers payments on other debts. The Browns pay auto loans of $600 per month, and a $250 monthly student loan. Adding these to the mortgage payment makes their total debt payments $2,251 per month:
$2,251 ÷ $6,250 = 36%
Because the debt ratio is right at the 36%* needed to qualify, they should qualify for the loan. This assumes that the Browns’ credit rating or score is sufficient to entitle them to the best credit terms. A low rating might have disqualified them even though they passed the ratios. On the other hand, an excellent rating may encourage the lender to bend the ratios if necessary. Also be aware that some first-time homebuyer programs offer more liberal ratios. if the Browns are applying for an adjustable rate loan, the lender may base the loan payment on a rate higher than that charged initially. This practice accounts for the likely increase in the rate after the first year of the loan.
If they were applying for an FHA loan, the criteria would change (even though $150,000 is more than the PHA can insure, we will use the same example). Since the FHA ratio of PITT to income should reach no more than 29%, and total debt payments no more than 41%, no problem arises here. In fact, they pass with more of a margin than in the conventional case.
The FHA uses a new way of calculating the maximum loan it will insure. A maximum percentage that varies by the price of the home and whether it is located in an area with traditionally high or low closing costs is applied to the value (the lesser of the price or appraised amount) of the home. These percentages range from a low of 97.15% up to 98.75%. The up-front mortgage insurance premium (MIP) and closing costs can be financed into the loan, but the borrower is required to make a cash investment equal to at least 3% of total purchase costs.
The purpose of these qualifying ratios is to prevent making loans to people who will find it difficult to meet the payment obligation each month. You may consider the maximum payment allowed more burdensome than you would like, and there is no reason you must get a loan that large. You may want to look for a home that is more modest. However, you may feel comfortable taking on a payment burden even more onerous than the maximum allowed. In that case, if you can present an argument for the increase by pointing out any “compensating factors” that might indicate your ability to handle the extra debt, you might secure a larger loan. For example, if the home is newly constructed or is especially energy efficient, the lender might employ a higher ratio reflecting the likely lower maintenance cost. If you make a larger than normal down payment, you might get a larger loan relative to your income. If your record shows you paid a comparable amount of rent in a timely manner, the lender might allow a higher payment-to-income ratio.
Loans specially tailored for first-time homebuyers often allow higher ratios for both mortgage payment and total debt than other conventional loans. For some pro-grams, the 28/36 percent ratios are extended to 33/3 8 percent. That means if you think you can qualify for one of these types of loans, you may expand your home search to a slightly more expensive range. On the other hand, if you are planning to use an Adjustable Rate Mortgage with less than a 10% down payment, the ratios probably will be lower (25/3 3 percent). That would narrow your range of houses a bit.
*These ratios apply to “conforming” loans. A conforming loan is one that is eligible for purchase by Fannie Mae or Freddie Mac. These agencies establish specific criteria for loans they purchase. More importantly, the government restricts the loan amount these agencies can purchase. The amount, which now stands at around $250,000, is raised each year. Loans over the limit are called “jumbo mortgages” and they carry higher interest rates and less attractive terms. |
