Why Do Some Loan Programs Allow for Higher Debt Ratios for Higher Income Borrowers?Written By: David Reed
Debt ratios over time have been used to determine affordability and are crucial pieces of information when evaluating a loan application. If a loan program asks for a front ratio of 28, that means the PITI represents 28 percent of gross monthly income. Over time, collective data indicates that when someone is making a housing payment, the suggested debt ratio implies the borrower can afford the payment and is unlikely to default due to an affordability issue. But there are different debt ratio requirements for different loan types.nbsp;
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Now lets look at someone with a gross monthly income of 3,500 and someone with 12,000. Lenders might review the 3,500 borrower with a program needing a 28 but the ratio for the amount the borrower wants is closer to 38. That might give some lenders pause. After the house payment, very little is left for other things. Especially if the new house payment is much higher than current rent. On the other hand, a lender might give the thumbs up on the higher income borrower. Why? Residual income.
Okay, a lender decides to make an exception with the 28 ratio guideline and approve a loan application pushing 35. The leftover income for the first individual would be somewhere near 1,100 or so. That might at first sound like a lot but 260 per week doesnt last very long. On the other hand, 35 percent of 12,000 is 4,200. The residual income available for everything else beyond the PITI is way much more. 1,500 to 2,000 is fairly realistic. Yes, higher income borrowers will also have higher expenses beyond a mortgage and car payments, but still, the amount left over each month will let a lender breathe a little easier.
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