High Debt-To-Income Ratio Won't Always Break Deal
WASHINGTON - Picture this: You pull all your financial records together to apply for a new mortgage. You tote up your monthly income and stack it against your total monthly payments for debts.
Turns out that your debt-to-income ratio - a critical factor in whether you get a home loan - is off the charts: 60 percent of your income goes to pay regular monthly debts. Since the mortgage industry typically sets a 33 percent to 36 percent ratio as the maximum permissible for conventional loans, you figure your application is going nowhere.
But you're wrong. Your application sails through, and you walk away with a loan carrying the best-available rate in the market despite a debt ratio that's nearly twice the standard limit.
A financial fantasy? For many borrowers, yes. But for a growing number of applicants, an important trend is taking shape nationwide.
Lenders using sophisticated new automated underwriting systems are abandoning the industry's traditional, rigid adherence to debt-ratio rules and are substituting far more flexible approaches. Rather than rejecting applicants with heavy debt loads out of hand, they are searching for offsetting factors in borrowers' profiles that will allow them to throw ratios out of the equation.
The offsets can take varying shapes: a sterling debt-repayment history, for example. Or substantial cash reserves that could be tapped in a pinch. Or a large equity stake in the property to be financed.
Typically the debt-to-income ratios that pass muster under the approach are in the upper 40 percent to 50 percent range. But at the extremes, lenders confirm that they have begun this year approving select home-loan applicants who carry stratospheric ratios by historic standards - 70 percent or beyond.
One Midwest mortgage executive says her firm has funded borrowers with debt ratios above 100 percent - applicants whose monthly installment-debt payments exceed their monthly income.
"Needless to say," she says, "this is not the sort of loan we could ever have made in the past."
Lenders aren't eager to shout from the rooftops about cases like this because they fear they'll raise expectations among the large numbers of debt-pressured consumers who don't have the sort of "compensating factors" necessary to qualify.
But they agree that the word needs to get out to thousands of other borrowers who assume their high debt ratios make obtaining, or refinancing, a home loan an impossible dream. These include:
-- Divorced parents with monthly child-support payments that are treated as installment debt, just like auto payments or a second mortgage, on loan applications. Such borrowers, especially husbands paying alimony, traditionally have found it extremely difficult to keep their ratios within standard guidelines.
-- Seniors on fixed, relatively low incomes who want to refinance their homes. Although they may have fine credit histories, homeowners on modest pensions often are denied financing because their monthly cash outflows represent too high a chunk of their monthly incomes.
-- Younger home-buying couples in their late 20s to mid-30s whose car payments, child care, student-loan and other regular payments throw their debt-to-income ratios into what lenders call "subprime" territory, exposing them to higher rates and fees.
Dozens of lenders nationwide now are not only considering applications from consumers like these, but are virtually ignoring traditional ratio rules and closing loans on the same terms they give regular, top-category applicants.
For example, Linda Terrasi, first vice president of Flagstar Bank in Bloomfield Hills, Mich., says her firm's use of the "Loan Prospector" computerized system developed by mortgage giant Freddie Mac has allowed it to approve recent applications where debt ratios ranged from 50 percent to 72 percent.
Freddie Mac's top expert on automated underwriting, Peter Maselli, cited the recent approval of a married couple in their late 20s as typical of how electronic credit-risk evaluations turn up ways to say yes to applicants who traditionally would have been turned down. The couple had a $24,000 annual income and wanted to buy a new house with a 20 percent down payment and a $104,000 mortgage.
Monthly payments on the loan would eat up 44 percent of their income. Total installment debt - the new mortgage plus existing debts - would consume a daunting 58 percent. Yet they were rated "Accept-Plus" by Loan Prospector - excellent risks, deserving market-rate treatment.
Why? Among other reasons, according to Maselli, the couple fit the statistical profile of "conservative" users of credit. They never drew down the maximum balances allowed them on credit cards and other installment accounts and, of course, they always paid on time.
The bottom line here? If you're basically a solid credit risk but happen to have high debt ratios, don't be shy. Lenders may not be as hung up about ratios in 1996 as they used to be.
(Copyright, 1996, Washington Post Writers Group)