New Higher Debt Ratios for Conforming Loans Now Allowed
Unless you’re in the mortgage industry you might not, and probably not, aware that recent changes in lending guidelines have quietly allowed borrowers to purchase a home and finance just a bit more than they used to. That is if they decided to do so. These new guidelines specifically address debt-to-income ratios. Debt-to-income ratios, or simply “debt ratios” are numbers that compare monthly credit obligations with gross monthly income. There are two such ratios conforming loans review, the housing ratio and the total debt ratio.
The housing ratio calculates the principal and interest payment and adds a monthly allotment for property taxes, insurance and any mortgage insurance when needed. This total is then divided by the gross monthly income of all borrowers on the application. If the housing payment adds up to $1,500 and gross monthly income is say $5,000, the housing ratio is $1,500 divided by $5,000 = .30 or 30. Conventional conforming loans, those underwritten to standards set forth by Fannie Mae and Freddie Mac set these guidelines and the suggested housing ratio is 33.
Total debt ratio takes the housing payment and adds other monthly credit obligations such as minimum payments on credit card balances, installment loans with more than 10 months remaining such as an automobile loan as well as other payments that will appear on a credit report such as student loans. Payments for spousal and child support payments are also calculated as well as day care expenses. The maximum suggested debt ratio for total debt was recently changed from 45% of gross monthly income to 50%. Note, this is gross monthly income, not “take home pay.”
When lenders approve loan applications and follow established guidelines the loan is then eligible for sale either to other lenders or directly to Fannie Mae or Freddie Mac. Lenders can sell individual loans or they can package loans together, bundling them and sell the lot. Yet as it relates to debt ratios, lenders have the ability to exceed suggested ratio guidelines as long as there is justification for the exception. Loans today are reviewed and receive an acceptance by uploading the electronic file to an automated underwriting system that quickly evaluates the entire loan application including income, debt and credit. In the past, even if the debt ratio was say 47 instead of 45, the loan could still receive an approval and the loan would still be eligible for sale.
When such an exception is made it’s typically because the lender feels there are other positive factors in the loan file which warrants the exception. For example, someone with a credit score of say 785 would likely receive an approval with a higher debt ratio compared to someone with a score of 620 and a smaller down payment. There are lending requirements and there are guidelines. A requirement is something like a borrower being required to occupy the property when financing for a primary residence is being reviewed. A guideline provides lenders with some “wiggle room” as long as there are other items in the file which warrant a guideline exception.