ratios
Before a loan can be approved, a mortgage underwriter is concerned with a borrower’s ability to repay the mortgage debt. The most important test of whether an applicant can afford a particular loan is by computing the various income ratios. These ratios, often established by the secondary market, have evolved through the years after reviewing millions of mortgage loans and are used as realistic guidelines for making mortgages with a low risk of default. Underwriters look at two income ratios: 1) the monthly housing ratio (or front-end ratio, as it is sometimes called) and 2) the debt-to-income ratio (or back-end ratio).
The monthly housing ratio is calculated by determining what percentage the proposed mortgage payment (PITI) would be in relation to the borrower(s) gross monthly income as follows:
PITI is an acronym that stands for principal, interest, taxes and insurance and includes not only the monthly principal and interest payment but also the hazard insurance payment, mortgage insurance payment, flood insurance payment, homeowner’s association dues and 1/12 of the annual property taxes.
However, individuals often have other monthly debt obligations in addition to mortgage payments. The ratio of these combined debts to gross monthly income must be calculated separately. This ratio is called the debt-to-income ratio and is calculated by dividing the sum of the PITI payment plus the minimum monthly debt payments by the gross monthly income. Also stated as a percentage, calculate it as follows:
Other debt payments include revolving charges (credit cards, department store cards, etc.), payments on installment debts that have more than 10 remaining payments (car loans, student loans, signature loans, etc.) and any alimony and/or child support payments.
