One of the single most important ratios considered when purchasing a new home or applying for a mortgage refinance is a borrower's debt-to-income ratio. Each monthly debt owed by the borrower, including car leases, is computed into this formula. The higher the debt-to-income ratio, the smaller the mortgage loan amount allowed.
Debt-to-income ratio is used by the lender to determine whether a borrower is capable of handling his current debt, including car leases, as well as any additional debt added by the new mortgage. The debt-to-income ratio is calculated twice: once before the mortgage, and known as the front-end ratio; and once after the new mortgage debt is added to the monthly payments, and known as the back-end ratio. The goal is for the back-end ratio to be 36 percent or lower for qualification purposes.
A borrower with a high debt-to-income ratio will have trouble meeting his new and current debt obligations, including his car lease, and therefore is a higher risk to the lender. Sometimes the lender will give the borrower the new credit, but at a higher interest rate to offset the risk.
The debt-to-income ratio is calculated at the time of application. The lender will total all of the monthly debt payments listed on the borrower's credit report, including her car lease for the top portion of the ratio. Then, she will divide the total monthly debt payments by the borrower's total pretax monthly income. If the borrower is salaried, her yearly salary is divided by 12. If the borrower is an hourly worker, her average weekly salary is multiplied by the number of weeks she works in a year. That number is divided by 12 to determine his monthly income. If the borrower is self-employed, the lender averages her net income as listed on his income taxes and then divides that by 12. The debt is divided into monthly income to determine the final debt-to-income ratio.
If a borrower's debt payments are too high, the borrower might not qualify for a new mortgage. This means that the lease payments on a new car need to be taken into consideration versus the borrower's other debt, if he will be looking to purchase a new home in the near future. If his lease payments are too high in relation to his income, it either could prevent him from qualifying for the new mortgage debt or could seriously limit the size of a new mortgage debt.
Many borrowers assume that a lease is different than a car loan in regards to a mortgage application. This is not true. A lender looks at a lease and a car loan in the same manner, assuming that both are debts until they are paid in full. However, if the car lease or loan is within 10 months of full repayment, the payment is not considered in the borrower's debt-to-income ratio.
- Photo Credit yellow car, a honda japanese sport car model image by alma_sacra from Fotolia.com
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