Some recent good news came out recently that took effect last July. Fannie Mae, the largest purchaser of residential home loans announced their new policy addressing debt-to-income ratios. Now, the new debt ratio guideline tops out at 50, up from 45.
Debt-to-Income Ratios Explained
To interpret those numbers, a debt-to-income ratio, or debt ratio, compares monthly credit obligations with gross monthly income from the individuals on the mortgage application. This is quite a change and something that shouldn’t be ignored. Apparently, Fannie Mae is addressing not necessarily the ability for borrowers to take on more debt but to address the problem millennials are having trying to qualify for a home loan while also being saddled with student debt.
Student loans today are the single largest form of debt outside of home loans. Today, the homeownership rate for those under 35 is its lowest point in decades. Homeownership helps spur other economic activity that helps keep an economy moving and student loan debt doesn’t appear to be abating any time soon, if at all.
Two Main Types of Debt Ratios
There are two different debt ratios reviewed with conventional loans. A “front” ratio which looks at housing payments and a “back” ratio which takes into consideration all monthly credit payments. The housing payment includes an amount for principal and interest, a monthly property tax and insurance payment and mortgage insurance where needed. For example, if the principal and interest payment is $2,000 and the gross monthly income is $6,000, the front ratio is 33. If we add a car payment of $500 and total student loan payments of $300, then the back ratio is $2,000 plus $800 = $2,800, or 46% of $6,000. In this example, a lender would probably approve this loan given other positive factors in the file. Debt ratios aren’t necessarily hard and fast but guide the lender as well as the automated underwriting system during the loan approval process.
However, let’s now say there are two car payments using this example totaling $1,200, not $500. That makes the back ratio 58 as total credit obligations add up to $3,500. In this scenario, the loan would very likely not get an approval. But if the debt ratios are raised from 45 to 50, that opens up homeownership that would otherwise not be available.
Now, let’s not suggest that first time home buyers go out and load up that credit card balance and buy a more expensive car but it does suggest that those who are responsible with their credit and previously applied for a conventional loan but turned down due to debt-to-income ratios might want to give us a call. We constantly review our database as well as previous loan applications and if we haven’t gotten in touch with you about this new policy you soon will hear from us. Or, you applied with another mortgage company who turned you down and were told your debt ratios were too high, you should call me right away. We have this very program today.