Mortgage lenders use the mortgage debt ratio to assess a borrower’s ability to make monthly mortgage payments. The ratio is calculated by dividing the borrower’s monthly income by the projected monthly mortgage payment. Lenders also consider other debts before approving a mortgage. A front-end ratio of 30% or less is generally required, while a regression rate above 40% would likely result in rejection.
Mortgage lenders use the mortgage debt ratio to see if potential homebuyers have the ability to make monthly mortgage payments. This ratio is calculated by taking the monthly income earned by a borrower and dividing it by the projected monthly mortgage payment. A stricter form of the mortgage debt ratio also takes into account the debt a borrower already owes each month and adds it to the mortgage payment. Mortgage lenders generally require borrowers to maintain a specific ratio before considering a mortgage.
Most potential home buyers do not have the cash to buy homes without some form of financial assistance. This help usually comes in the form of a mortgage, in which a bank or other certified mortgage lender provides a loan to enable the borrower to purchase a home. The borrower must provide a small down payment and then repay the loan, along with interest at a predetermined rate, in monthly installments. Since a mortgage lender risks losing its investment if the borrower defaults on his or her mortgage, a mortgage debt ratio can be used to determine the borrower’s financial situation.
As an example of a mortgage debt ratio, imagine that a lender is scheduled to provide a mortgage that will cost the borrower $1,000 United States Dollars (USD) in monthly mortgage payments. The borrower has a monthly income of $4,000 USD. This means that the ratio of mortgage payments to earnings, also known as the front-end ratio, is $1,000 divided by $4,000, which equals .25 or 25 percent.
Mortgage lenders will also want to know about other debts a borrower has, as that will also affect their ability to repay the loan. As a result, the regression index is calculated by adding this foreign debt to the amount owed on the mortgage. Using the example above, imagine that the borrower also had $500 in monthly debt from credit card payments. This would be added to the $1,000 mortgage payment for a total projected monthly debt of $1,500. The $1,500 would then be divided by the monthly revenue of $4,000 to get a retracement ratio of .375, or 37.5 percent.
Although different mortgage lenders have different standards and may take other factors into account, they generally require a certain mortgage debt ratio before proceeding. For a frontal relationship, the percentage should not be more than 30 percent. Anything above a 40 percent regression rate would likely cause lenders to reject a home loan.
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