Loan Modifications and Your Debt-to-Income Ratio

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The new year is starting out on the right foot for home buyers – with extremely low interest rates. In fact, a 30 year fixed- rate mortgage is averaging 3.7%! As interest rates haven’t been this low for several years, many people are considering applying for loan modifications on their existing mortgages.

Although you may be extremely tempted to refinance your existing home loan, it is important to know whether you would even be eligible for a modification before jumping headfirst into the process.

What is your debt-to-income ratio?

You definitely need to have the answer to this question before applying for a loan modification so that you have realistic expectations about what results to expect.

In order to know your debt-to-income ratio, you must first understand how the ratio is calculated.

During any loan application procedure, including traditional loans and mortgage refinancing (otherwise known as loan modifications), your debt-to-income ratio is a critical part of the process. Your debt-to-income ratio, or your DTI, will be a determining factor in whether or not you become a homeowner.

Your DTI ratio is defined as how much of your monthly income (gross) is already tied up in paying for your current debts and financial obligations. You can use a DTI ratio calculator to give yourself a basic idea of your debt-to-income ratio.

There are two ways to calculate your DTI ratio. The first includes comparing your gross income solely to your housing related debts, like your mortgage payment, homeowner’s insurance, property taxes and other house related expenses. This is referred to as your front-end debt-to-income ratio.

The second way to calculate debt to income ratio is a little more aggressive, and compares your monthly income with how much you spend each month on all debts, not just housing related debts. This would mean you would include child support, alimony, credit card payments, car payments and any other recurring debt in addition to all housing related debts. This is known as your back-end DTI ratio.

Your front-end ratio should not exceed 31%. This means that your housing expenses should not exceed 31% of how much money you make each month, before taxes. Lenders look at your front-end debt-to-income ratio to ensure that you have room left in your monthly budget to pay for the loan you’re applying for.

Lenders also use the back-end DTI ratio together with your front-end ratio to determine your eligibility for a loan. All lenders are different, and may have slightly different guidelines for determining what is an acceptable DTI ratio (either front or back-end).

It’s important to approach a mortgage refinance with as much information as possible, so do some calculating before you spend any time applying for a loan modification. If your front-end debt-to-income ration is higher than 31%, don’t panic. There are ways to lower your DTI before you apply so that you are not turned away. For more information, or if you know you need to lower your DTI ratio and want to learn how, schedule a free meeting with us today.

 

Image credit: Jacob Edward (flickr)

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2 Responses to Loan Modifications and Your Debt-to-Income Ratio

  1. Pingback: Divorce and Your Mortgage: The Dirty Little Secret | Veitengruber Law

  2. Pingback: Denied a Loan Modification? Know Your Options. | Veitengruber Law

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