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Ratios And The Real World

by David Reed

How much do you qualify for? Don't go shopping for a house unless you know how much you're qualified for. Get qualified first. Make sure your debt ratios are in line. 38%. No more. Blah, blah, blah. Guess what? Qualification by ratios, once an art form, is now dinosaur meat.

You know ratios, right? It's a percentage calculated by dividing your monthly credit obligations by your gross monthly income. If your monthly bills are $1,000 and your house payment is $2,000 you have $3,000 worth of obligations. If your monthly income is $8,000 then your ratio is .375, or 37.5%. You're qualified.

Ratios are used to test an historical “affordability” model. If your ratios were above 38 on many loan programs, it's possible a lender would ask that you buy a smaller home or borrow less money. Because, actuarially speaking, higher debt ratios point to a greater likelihood of default. However, with the fine tuning of Automated Underwriting Systems (AUS) often these ratios come to mean less and less in terms of qualification. Ratios aren't disregarded, but they're less of a rule and more of a guideline.

You can ask any loan officer who's been in the business for 10 years if they've seen a difference in how ratios and loan qualification have diverged. It used to be that anything over 41 required something just short of a first born child to be approved. Now, ratios above 41 are an everyday occurrence. You'll find many loan officers who can tell you stories of getting borrowers approved with ratios of 50 and beyond. Heck, I recall a loan where the ratio was nearly 70, How can this happen? With an emphasis on three things: Credit, Reserves, LTV.

First and foremost, AUS programs place a greater consideration on a customers Credit. If your credit score is in the high 700 range, then you can expect your ratios to be relaxed. The next most important consideration is Reserves. Reserves are borrowers assets after closing, and can include things other than cash in the bank but also stock, mutual funds, retirement accounts, IRAs and 401(k) accounts. The higher the Reserve balance after closing, expect your “affordability index” to increase.

Lastly, your equity position in the house, or Loan to Value (LTV). If you only put down 5%, then don't expect your ratios to go beyond loan guidelines. But if you put 20% or more as a downpayment, then you may be able to go ahead and borrow a little more than thought you could.

One word though, many times what a borrower qualifies for is much greater than their comfort level. Just because you can borrow with debt ratios in the 60s it's not any fun if you can't sleep at night worrying about the payments. But if you feel confident in your ability to pay then by all means don't let a ratio guideline thwart your new home search. This means that when your told to go get prequalified before you go shopping, then you may be short changing yourself when it comes to buying the home you really, really want. If there's a house that is your perfect “dream home” but pushes your debt ratios higher than some guidelines suggest, go ahead, Kick it up a notch.

Published: January 24, 2003

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