Depending on the type of loan you are trying to obtain, your lender will use any of several industry lending ratios to determine whether you qualify for a loan, what type of loan you may qualify for, or the value of the loan you qualify for.
While these are not the only factors used in deciding your creditworthiness, they do play a big part in your lender’s calculations. Knowing a little about these ratios can better equip you for the loan application process.
Here are some of the ratios your lender will use to decide whether you should qualify for a mortgage as you shop for your next home.
This is one of a few types of leverage ratios that lenders use to determine how much a loan applicant can afford to pay every month.
This ratio looks at the portion of your monthly gross income that is already going toward paying off your debts. This can include credit cards, auto loans, and other open-account credit payments you may have.
A low debt-to-income ratio tells your lender that you have plenty of money left over, after paying your debts, which could go toward payment on this new loan. It means that you are more likely to be able to afford the loan payments.
If you have a high debt-to-income ratio, on the other hand, lenders may foresee some difficulty in collecting their payments in the future.
Housing Expense Ratio
Financial ratios like this are used by lenders to determine the maximum value of a loan, or what you can afford. Banks tally the total cost of your potential homeownership including:
- Mortgage payments
- Homeowner’s insurance
- Property taxes
- HOA fees
With these total expenses tallied, a lender can determine how much of your gross income will go toward your potential new home. Ideal ratios for banks may vary, but a good rule of thumb is that if these costs equal less than 25% of your income, you are a safe bet.
Before you can get a loan, your lender will appraise the value of your home. That appraisal is used in qualifying ratios like this one. A bank will limit the amount of any loan to a percentage of the assessed value of a home.
That percentage often depends on the credit score of the borrower and can vary. Typically, a loan for more than 80% of a home’s value is considered too high. Banks often add assurances like private mortgage insurance to these loans.
Other Lending Ratios
The loan underwriting process is not always as formulaic as it might seem. Each lender might use a different set of ratios depending on several factors including the applicant’s history, the type of loan, and the value of the loan.
Businesses looking to obtain a loan have a number of other Financial stress to jump through. They are subject to their own types of lending ratios.
Small business loans, for example, often depend on ratios like the working capital ratio, another leverage ratio that looks at assets vs. liabilities. Larger companies are subject to Debt-to-Equity ratios that focus on the capital structure across several shareholders.
Do the Research
Before you start your next loan application process, find the lending ratios that apply to your situation. When you know a little about the underwriting process your application will go through, you’ll be more likely to find a lender and program for you.
If you are looking into buying your own home, it may be the right call to hire a mortgage broker to assist you along the way. Doing so can eliminate a lot of the potential headaches and hang-ups home shoppers often face.
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