Chapter 4: Qualifying for a Mortgage

What are the two primary mathematical methods used to determine mortgage eligibility?

Ratios and the Residual Method

What is the ratio’s method?

Uses your DTI to determine your creditworthiness. Determining what proportion of your income goes towards debt payments.

What is the residual method?

Aims to ensure that the borrower has sufficient income remaining after all essential expenses are paid to cover daily living costs and unexpected expenses.

What is the debt to income ratio (DTI)

Compares your recurring monthly debt payments against your monthly gross income

What is DTI also known for?

Being a back end ratio.

Equation for debt to income ratio (DTI)

(Total monthly debt payments ÷ gross monthly income) x 100

What does GMI stand for, and what is it?

Gross Monthly Income; it's the income before any deductions.

What is the Housing Ratio also known as, and what does it measure?

Front or Inside Ratio; it measures the percentage of GMI dedicated to monthly housing expenses.

What expenses are included in the numerator of the Housing Ratio?

(PITI) + HOA dues

• Principal

• Interest

• Taxes

• Insurance

What is the typical maximum acceptable Housing Ratio for conforming mortgages?

28%

What is the Debt Ratio also known as, and what does it measure?

Back, Outside, or Second Ratio; it includes monthly housing expenses plus other monthly liabilities with more than ten months remaining.

Name two types of monthly liabilities that are always counted in the Debt Ratio, regardless of the time left on the loan.

Car leases and credit card payments.

What is the typical maximum acceptable Debt Ratio for conforming mortgage programs?

36%

What is the housing ratio?

percentage that indicates how much of a borrower's gross monthly income is allocated to housing expenses. (PITI)

Housing Ratio Equation

(PITI + HOA / Gross Monthly Income) * 100

For which type of mortgage program is a Debt Ratio of 41% acceptable?

FHA and VA mortgages

What are "compensating factors" in mortgage qualification?

Overriding considerations (like a large down payment) that can help an applicant qualify even if their ratios are slightly off.

Explain the concept of "pre-qualification" in the context of ratios.

Working the ratio calculations backward to determine the maximum mortgage or home purchase an applicant can qualify for before a specific home or loan program is identified.

Which mortgage program primarily uses the Residual Method of qualification?

VA mortgages

How does the Residual Method determine affordability?

By subtracting all expenses (including the mortgage payment) from the applicant's income; if a positive residual remains, they qualify.

Name three types of expenses considered in the Residual Method that are not typically part of the Debt Ratio calculation.

Federal income taxes, State income taxes, Social Security.

What is a FICO score, and what does it indicate to lenders?

A credit score used by lenders to predict the risk of loan default.

What FICO score is generally considered a high credit risk?

Below 620

What does AUS stand for in the context of mortgage underwriting?

Automated Underwriting Systems

Name two common Automated Underwriting Systems

Freddie Mac's Loan Prospector (LP) and Fannie Mae's Desktop Underwriter (DU)

What is Freddie Macs Automated underwriting system called?

Loan Prospector (LP)

What is Fannie Mae’s automated underwriting system called?

Desktop Underwriter (DU)

How can a high rating from an AUS benefit a loan applicant?

It can allow for less documentation, a smaller down payment, or higher underwriting ratios.