One of the largest hurdles in getting any loan is your debt ratio. This is the percentage of your income that goes towards your monthly obligations. Certain loan programs have maximum debt ratios already in place, allowing lenders little leeway in the programs they can offer their borrowers while other programs, especially non-QM loans, do not have any set debt ratio. In order to qualify for a QM loan, your debt ratio cannot exceed 43%. This does not mean you will never get a loan if your ratio is higher than that; it just means you will have to look at non-qualified loans with smaller or private lenders.
Calculating your Debt Ratio
One problem with determining your debt ratio is that you might get a different percentage than your lender obtains. This depends on how the lender qualifies your income. If you are a standard salaried employee, it is fairly easy to figure out your monthly income as you make the same amount every month. Remember, your gross monthly income is how the debt ratio is calculated. Your monthly obligations divided by the gross monthly income gives you your ratio. What if you do not receive a straight salary? Then there are a few calculations that the lender will need to perform before coming up with your debt ratio – this is where the numbers often differ between borrower and lender. If you are self-employed, your expenses will take away from your gross monthly income and if you claim less income on your tax returns than you actually make, you will only be eligible to use the income that is reporting on your tax returns, making your debt ratio even higher.
Dealing with a High Debt Ratio
Sometimes borrowers have a good reason for a high debt ratio. Sometimes it is a one-time occurrence, such as something bad happened – a car accident; car breakdown; or medical emergency that has caused you to charge excessively. If this is the case, you can explain the high ratio, show how you plan to pay it down and offer compensating factors, such as six to twelve months in reserves or an excessively high credit score. Lenders want to see that despite your high debt ratio that you are able to handle your financial responsibilities without a hiccup. If you have a credit history blemished with late payments and you are trying to get a high DTI pushed through on a loan, your chances are much lower than if you had compensating factors, such as great credit. If you do have many late payments on your credit report, it is best to wait until they are at least 12 months behind you before applying for a mortgage.
Why is a High Debt Ratio Bad?
Many borrowers wonder why lenders have to cap their debt ratio at 43%. Or why they are suddenly “non-qualified” if their ratio is higher than the set amount. This 43% was set by the government agencies overseeing the mortgage industry and its eventual comeback after the mortgage crisis the industry just went through. Studies show that any debts exceeding 43% of a person’s income make it much harder to stay on top of payments, especially if an unforeseen circumstance were to occur. The fewer debts you have, the more likely it is you will stay on top of your mortgage payments. Because of this guarantee of sorts, lenders that max their debt ratio at 43% along with a few other stipulations, such as keeping the fees at less than 3% of the loan amount; not allowing any odd terms, such as negative amortization or interest-only payments; and keeping the loan term at 30 years or less are able to have protection against litigation from borrowers that do lose their home due to defaulting on their payments. This guarantee is a very large asset for lenders, enabling them to continue lending to other “good” borrowers while leaving those that do not meet those requirements in the dust.
Non-Qualified Loans Allow for DTI Flexibility
The good news is that with the addition of the Ability to Repay Rule, many lenders are able to offer non-QM loans and still minimize their risk of getting sued by defaulting borrowers. The ATR is like a double check on the borrower, ensuring that he can, in fact, make his payments without feeling financial pressure. It is a guarantee to the government that the lender went through enough steps to verify the borrower has the assets, income, and employment he says he has in order to get the loan. There is no more taking a borrower’s word for it, as occurred in the old “Stated Income or Stated Income and Asset Loans.” Today, everything is verified no matter what and if it cannot be verified, it cannot be used for qualification purposes.
In short, if you have a debt ratio exceeding 43%, you can still get a loan as long as your other financial affairs are in place. This means that your credit score is decent – typically above 620; you have reserves on hand; and the lender can easily verify your income and assets. You will fall under the non-QM loans guidelines, but this does not mean subprime, like it used to be. It means that your loan will likely come from a smaller lender that either keeps the loan on his books and/or sells it to private investors. Your loan will not likely come from a big-name lender, but that is okay because you will get the mortgage you need with the same scrutiny that any other borrower would go through for a conforming or qualified loan.
Non-QM loans are not a punishment; in fact, they are a great way to ensure that more people become homeowners that want to become homeowners. The new mortgage guidelines that came out right after the mortgage crisis made it almost impossible for anyone to get a loan unless everything was in perfect shape, including their credit, income, assets, employment, and debt-ratio. If you need a non-QM loan, make sure you shop around to find the one that is right for your situation.