Lenders today have multiple rules they must follow in order to be in compliance with federal and state regulations. One of those regulations can be found in the “Ability to Repay,” or ATR rule issued by the Consumer Financial Protection Bureau, or CFPB, back in 2014. Affordability was inserted after regulators discovered more and more mortgage lenders routinely ignoring income or asset information when issuing a new loan program. This of course contributed to the financial problems that began to negatively affect the economy from 2008-2009, as many borrowers who did not have their income verified ultimately defaulted on their loans. The CFPB put a stop to that with the ATR. Affordability is determined by calculating debt-to-income ratios, or simply “debt ratios.”
Debt Ratios Explained
Debt ratios are calculated by comparing monthly credit obligations with gross monthly income. Most programs have two such ratios, one reserved for just the mortgage payment only and one for the mortgage payment plus additional credit payments. The mortgage payment includes the payment that goes to the mortgage company plus taxes and insurance and the other ratio includes the first one plus any that would appear on a credit report. Spousal and child support payments are also included in this second ratio along with any amounts paid each month for daycare. Other regular expenses such as food and utilities are left out of this number.
But as there are different types of debt, there are also different types of debt for the very same purchase. A common example is a car payment, which might be the most common of all. Consumers have to get to work and so they need a car. Consumers typically finance these car purchases as shelling out several thousands of dollars for an outright purchase can put a real dent in a bank account.
Buying a car can mean owning it and also leasing the vehicle. Yes, there’s a difference. When someone owns and finances a car, the car belongs to the borrower with a recorded lien issued by the financier. The owners make regular car payments each month until the car is paid off. Once the car is paid off, the lien is removed and the owners own the car outright. This type of debt falls into the “installment” category.
Leasing vs. Owning
Buying a car can also mean leasing the vehicle instead of owning it. With a lease, the buyer makes payments each month for a specific period of time. At the end of the lease period, the car is turned back over to the entity financing the vehicle. An automobile lease might be for 24 or 36 months and even longer. Some lease periods are as long as 60 months. The longer the lease period the lower the monthly payment. The drawback for a longer period is more interest is paid in much the same manner that shorter or longer mortgage terms affect the amount of interest paid over the life of the loan.
Now comes the debt ratios part. With an outright purchase, the lender adds the monthly payment to the debt ratio calculation. When there are less than 10 months remaining on the note, however, most mortgage programs no longer consider that debt in the ratio number, knowing the borrower is likely to keep the car free and clear into the future.
With a lease the lender knows that at the end of the lease term the vehicle is returned but at the same time the borrower will still need a vehicle in order to get to work, school and take various trips of all sorts. The lender will still count the lease payments and ignoring the less-than-10 payment guideline and assumes a new lease or purchase will be required. Borrowers can expect to explain the planned disposition of the vehicle upon the expiration of the lease. Will a new lease be originated? Will the borrower buy the car and if financing, what will the terms be? These and other questions need to be answered when there is a lease involved.