Early in my originating career I was asked by a young couple if they would qualify for a certain loan. The refinance would pay for their house to be re-roofed and possibly consolidate some consumer debt. Their credit was sterling, they had reserves in the bank and they’d been at their jobs for more than a couple of years. Pretty straightforward…could I tell them if an underwriter would find their income sufficient to cover the higher loan payment, especially now that they had a car payment and had to start paying on their student loans?
Could I? I had no idea! If it looked, smelled or remotely tasted like math, I’d always found some way to let my processor, Tiffany, handle it. She loved numbers! I figured I had no business interfering with her pleasure. But this time, those numbers were literally stacked against me. Tiffany was out of the office and these folks wanted answers now. They were looking to me to be the professional I professed to be.
Somewhere, I’d stashed the notes I’d made months ago when Tiff was showing me how she figured ratios…please, dear Lord, tell me I’d brought ‘em with me! While those kids waited anxiously across from me, I rustled around in my bag, making small talk 'til I came up with the chicken scratches that were to save my reputation. And save it, they did. That young couple will never know how nervous I was as I fumbled with my HP and somehow convinced all of us I knew what I was doing. And that’s exactly as it should be. Figuring ratios is One of Those Things every professional loan mortgage originator must know to earn the trust of their clients. So, for a moment, assume you’re qualifying that young couple, yourself:
Housing ratio (front end) includes anything to do with monthly housing payments, such as principal, interest, property taxes, property insurance, mortgage insurance, flood insurance and HOA dues, if applicable, divided by the gross monthly income. This means if you are given an annual figure for any of these, it will need to be divided by 12 to arrive at the monthly figure. You’ll need to know this housing figure before proceeding to the next step.
Debt to income ratio (back end) is generally determined by looking at the credit report for verification of outstanding debts and their monthly payments. Credit cards like Visa AND store cards like Macy’s AND monthly installment debt with less than 10 months left to pay (such as a car loan, student loan or personal loan) are all added to the housing figure and this figure is divided by the gross monthly income. Cell phone payments, utilities, life insurance, groceries, child care, gasoline and the like are NEVER included in these calculations.
DIVIDE the housing expense figure by the GROSS income figure to get the front end ratio.
DIVIDE the housing PLUS monthly debt expense total by the GROSS income figure to get the back end ratio.
MONTHLY HOUSING EXPENSE = $1500 principal, interest, taxes and insurance (hazard, flood and mortgage insurance, if it applies) and HOA dues if applicable, as well.
OTHER MONTHLY DEBT EXPENSES:
ADD other monthly installment debt with more than 10 months left to pay = Car loan $300/mo
ADD student loan = $100/mo
ADD revolving major credit cards like Visa = $25/mo
ADD revolving store credit cards like Target or Macy’s = $10
$1500 plus $300 plus $100 plus $25 plus $10 = $1935 total monthly debt
TAKE THE MONTHLY HOUSING EXPENSE AND DIVIDE IT BY GROSS MONTHLY INCOME = THE FRONT END RATIO (For this example $6000) $1500/$6000 = .2500 (or 25.00% for the housing ratio - just move that decimal 2 places to the right to make it a percentage)
ADD MONTHLY HOUSING EXPENSE PLUS ALL MONTHLY DEBT TOGETHER AND DIVIDE THE TOTAL BY GROSS MONTHLY INCOME = THE BACK END RATIO $1935/$6000 = .3225 (or 32.25% - remember to move that decimal 2 places to the right)
Looks like the ratios would be 25/32 for underwriting purposes. Looks like it could be a conventional loan, with their sterling credit, reserves and time on their jobs. Looks like this one could come together, and looks like you know what you’re doing.