Loans With a Debt-to-Income Ratio
Lenders use debt-to-income (DTI) ratios when underwriting most consumer loans and some business loan products. Debt-to-income ratios show how much of the borrower's gross monthly income goes toward debt payments. Lenders impose DTI maximums to ensure that borrowers can afford monthly payments before approving applications for new loans. Applicants with DTI levels above loan guidelines can qualify for a reduced amount or are declined for the loan.
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Fixed-Rate Loans
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Lenders use DTI ratios when underwriting fixed-interest loans such as car loans and fixed-rate mortgages. The Federal Housing Administration, which insures loans for first-time home buyers, caps DTI ratios at 41 percent, and most lenders impose similar DTI restrictions. However, the FHA and other lenders do make exceptions for people who are refinancing and can benefit from the loan. In some situations, mortgage lenders approve loans with DTI ratios as high as 55 percent. DTI limits on car loans generally are similar to limits on home loans.
Home Equity Lines Of Credit
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The maximum DTI ratios on home equity lines of credit (HELOC) vary between 40 and 55 percent. However, because HELOCs have variable rates and the balance can change on a monthly basis, DTI calculations are imprecise. Most lenders use a formula that involves multiplying the line amount by 1.2 percent and dividing the result by 12 to come up with a hypothetical monthly payment amount. To offset some of the risk associated with underwriting variable rate loans, lenders usually only approve applicants who have high credit scores.
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Business Loans
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Lenders do not use DTI ratios to qualify business entities for loans. However, when small business owners apply for credit under the name of their business, lenders normally require the business owner to sign as a loan guarantor. The guarantor agrees to pay the loan in the event the business fails. Lenders use DTI ratios to qualify business owners who sign loans as guarantors. DTI limits on business loans usually are more conservative than on consumer debt and are often limited to 36 percent or less.
Other Credit Products
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Lenders writing government-backed student loans cannot use DTI ratios to qualify students for the loans, because many students have no income when they apply for the loans. However, if a student obtains a private loan, the lender may require the student to add a co-signer to the application, and the lender only accepts co-signers who meet DTI ratio guidelines. Lenders typically do not use DTI ratios for credit card products and instead rely on the applicant's credit score to approve or decline the card application.
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