What Are Qualifying Ratios?
Let me explain qualifying ratios directly: these are financial metrics that lenders like banks use to gauge if you can repay a loan by looking at your debt compared to your income. Your qualifying ratio comes out as a percentage, and it heavily influences whether you get approved for financing and what terms you might receive.
In simple terms, lenders rely on these ratios—percentages that pit your debt obligations against your income—to decide on loan applications.
Key Takeaways
- The debt-to-income ratio (total expenses divided by gross income) is used in underwriting personal loans, credit card applications, and mortgages.
- The housing expense ratio (housing-related expenses divided by gross income) is used in underwriting mortgages.
- While each lender sets its own qualifying standards, what's generally desirable is a debt-to-income ratio of 36% or less, and a housing expense ratio of 28%.
How Qualifying Ratios Work
You should know that qualifying ratio requirements differ across lenders and loan programs. They're often paired with your credit score when evaluating your application.
For consumer financing, the two big ones are the debt-to-income ratio and the housing expense ratio. Standard credit products like personal loans and credit cards emphasize your debt-to-income ratio. Mortgages use both the housing expense ratio and the debt-to-income ratio.
Keep in mind that online lenders and credit card issuers frequently use algorithms for underwriting, which can approve applications in minutes.
Qualifying Ratios in Personal Loans
When underwriting personal loans and credit cards, lenders zero in on your debt-to-income ratio and credit score, giving them roughly equal importance.
The debt-to-income ratio, or DTI, can be figured monthly or annually—it measures your regular debt payments against your gross income, showing how much is going out compared to what's coming in. You calculate it by dividing your outstanding debt payments by your total income. For the monthly version, it's debt payments divided by monthly gross income.
Each lender sets its own approval parameters, but high-quality ones typically want a DTI of about 36% or less. Subprime lenders might go up to around 43%.
Qualifying Ratios in Mortgage Loans
For mortgages, underwriting looks at two ratios plus your credit score: the housing expense ratio and the debt-to-income ratio.
Note that in mortgages, the housing expense ratio is often called the front-end ratio, and the debt-to-income ratio is the back-end ratio.
Housing Expense Ratio
The housing expense ratio compares your total housing costs to your gross income. Lenders consider things like mortgage principal and interest, but they might also include homeowners insurance, utilities, property taxes, HOA fees, and mortgage insurance. You divide the sum of these by your income, using monthly or annual figures.
Underwriters use this not just for approval but to decide how much you can borrow. Most require it to be 28% or less, though higher might be okay with factors like a low loan-to-value ratio or strong credit. In pricey areas like New York or San Francisco, it's common for housing expenses to hit one-third of income.
Debt-to-Income Ratio
The debt-to-income ratio for mortgages is the same as in personal loans. Lenders generally aim for 36%, but programs like Fannie Mae allow up to 45%, and FHA loans can go to about 50%.
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