As previously stated, in determining whether to grant a loan modification, there are three central factors that a lender takes into consideration: 1) the financial hardship of the borrower; 2) whether the borrower is currently delinquent on mortgage payments or is at risk of becoming delinquent in the immediate future; and 3) the borrower’s debt-to-income ratios. While the first two factors seem relatively straightforward, understanding your debt-to-income ratios is oftentimes confusing and may seem complex; yet understanding your debt-to-income ratios is very important.
What is a debt-to-income ratio?
Simply put, a “debt-to-income ratio” (“DTI”) is the percentage of a homeowner’s gross monthly income that goes toward paying the homeowner’s debts. In the context of a home loan modification, two DTI ratios are taken into consideration: a “front-end” DTI ratio and a “back-end” DTI ratio.
How to Calculate Your Front-end DTI Ratio
To calculate your front-end DTI ratio, you divide your total “monthly first mortgage payment” by your gross monthly household income:
Monthly House Payment ÷ Gross Monthly Household Income= Front-end DTI Ratio
Your “monthly first mortgage payment” is often referred to as “PITIA.” “PITIA” is defined as principal, interest, taxes, insurance (including homeowners insurance and hazard and flood insurance) and homeowners association fees (if applicable). Note that if you pay property taxes, insurance, and/or homeowners association fees separately from your mortgage principal and interest, these expenses need to be added to your total “monthly first mortgage payment.”
How to Calculate Your Back-end DTI Ratio
To calculate your back-end DTI ratio, you add up all of your monthly debt payments (do not include any expenses that are not listed on your credit report), which may include:
• Your “house payment” or PITIA (this was used in calculating your front-end DTI)
• Your second mortgage or HELOC payment
• Credit card payments
• Automobile loan or lease payments
• Alimony/child support
• Educational/student loan payments
• Any personal loans
• Any other accounts reported in your credit reports
After adding all of these monthly debts up, you then take the total and divide it by your total gross monthly household income:
Monthly Debt Payments ÷ Gross Monthly Household Income= Back-end DTI Ratio
Why are your Debt-to-Income Ratios Important?
Because lenders want to avoid as much risk as possible, they will pay special attention to your DTI ratios. In essence, lenders use your DTI ratios as indicators of your ability to repay your debts. Therefore, if your DTI ratios are low, lenders may be more inclined to assist you because they believe that you have a higher probability of repaying your debts. On the other hand, if your DTI ratios are high, lenders may be less likely to assist you because they believe you have a lower probability of repaying your debts (and, therefore, you are a greater risk). Because your DTI ratios play such a significant role in the home loan modification process, it is a good idea for you to do a rough calculation of your own front-end and back-end DTI ratios. By doing your own calculation, you can estimate whether a lender is more likely or less likely to grant you a loan modification.
Today, lenders have specific target ranges and limitations on allowable DTI ratios for loan modifications. Although your lender may have slightly differing DTI ratio targets and limitations, most lenders are willing to grant loan modifications to homeowner’s whose DTI ratios are below 50%. Remember, lenders want to avoid risk and only want to extend loan modifications to homeowners who have a high probability of repaying their debts.
As always, remember that the earlier you look into the requirements of loan modifications and begin the process, the better. Additionally, seeking help early on is very important. Always remember that even if you are unsure about whether you qualify for a loan modification, it is better to ask earlier on. Lastly, remember that a qualified attorney who has experience in working with loan modifications can be extremely beneficial to you and can assist you in working directly with your lender and in protecting your interests.
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