Qualifying Ratios

Qualifying ratios are ratios that are used by lenders in the underwriting approval process for loans. The two main qualifying ratios that a borrower should be aware of include debt-to-income and the housing expense ratio.

Qualifying ratio requirements can vary across lenders and loan programs. They are a consideration used in combination with a borrower’s credit score. Standard credit products will focus on a borrower’s debt-to-income ratio. Mortgage loans will use both a housing expense ratio and a debt-to-income ratio.

Personal loans may have automated or conventional loan application procedures. Automated loan applications are used by online lenders and for credit cards. Conventional loan applications are typically submitted by a loan officer at a financial institution. Automated loan underwriting can be done in minutes while conventional loan processes may take longer.

In the underwriting process for all types of personal loans and credit cards the lender will focus on two factors, debt-to-income and a borrower’s credit score. Debt-to-income may be calculated monthly or annually. It is a ratio that considers a borrower’s debt payments as a percentage of their total income. High quality lenders will require a debt-to-income ratio of approximately 36% or less. Subprime and other alternative lenders may allow for debt-to-income ratios of up to approximately 43%.

A borrower’s debt-to-income ratio is just as important to a lender as a borrower’s credit score. Lenders analyze both debt-to-income and credit scores in loan underwriting with each lender having their own specified parameters for loan approval.

Mortgage loan underwriting analyzes two types of ratios along with a borrower’s credit score. Mortgage lenders will look at a borrower’s housing expense ratio which may also be referred to as a front-end ratio. They will also consider a borrower’s debt-to-income ratio, also referred to as a back-end ratio.

Lenders have numerous expenses that they may require in the housing expense ratio. This ratio is generally a comparison of the borrower’s total housing expenses to their total income. Lenders usually focus on the mortgage expense however they may also require other expenses such as home insurance and utility bills. The housing expense ratio is typically required to be approximately 28% or less. Lenders also use this ratio in the underwriting process to determine how much principal a borrower is eligible for.

The back-end ratio or debt-to-income ratio is the same ratio used in personal loan products. It considers a borrower’s total debt to total income. Lenders generally also look for a debt-to-income ratio of 36% for mortgage loans as well. Some government sponsored loan programs may have looser standards for debt-to-income with Fannie Mae accepting debt-to-income ratios of approximately 45% and Federal Housing Administration loans accepting debt-to-income of approximately 50%.