What Is a Qualification Ratio?

The term qualification ratio refers to the measure of a borrower's creditworthiness that ♊helps lenders decide whether to extend credit. A qualification ratio is used in the underwriting process to calculate how likely it would be for a b💎orrower to repay a loan.

Lenders normally use one of two qualification ratios in their underwriting process. The first is the monthly 澳洲幸运5开奖号码历史查询:debt-to-income ratio (DTI), while the second is the 澳洲幸运5开奖号码历史查询:back-end ratio, which calculates the monthly debt payment to in🌜come. Qualification ratios also determine the terms of any credit application, including repayment terms and interest rates.

Understanding Qualification Ratios

Consumer credit applications provide mortgage lenders with a window into applicants' personal and financial situations. Consumers are required to provide information such as their name, address, and financial information on these applications. This information includes employment information, income, and debts. Lenders use this information in the 澳洲幸运5开奖号码历史查询:underwriting process to determine whether or not to approve a consumer's credit application for most credi👍t products, especially loans and mortgages.

A borrower's housing expenses, including 澳洲幸运5开奖号码历史查询:homeowners insurance, taxes, utilities, and neighborhood or association fees, cannot exceed 28% of a borrower's monthly 澳洲幸运5开奖号码历史查询:gross income. Another qualification ratio, the borrower’s DTI, includes housing expenses plus debt and generally cannot exceed 36% of monthly gross income.

Higher ratios indicate an increased risk of default. However, some lenders may accept higher ratios in exchange for certain factors, such as substantial 澳洲幸运5开奖号码历史查询:down payments, sizable savings, and favorable 澳洲幸运5开奖号码历史查询:credit scores. Fo💜r example, a lender may offer a mortgage to a borrower with a high front-end ratio if they pay half of the purchase price as a down payment.

As mentioned above, lenders generally use one of two qualification ratios to determine the likelihood of repayment. This is based on the information provided by the applicant and their 澳洲幸运5开奖号码历史查询:credit report.

The first ratio involves the applicant's total monthly debt to total monthly income, while the other calculates the total monthly debt payments versus the total monthly income. These ratios take the total annual 澳洲幸运5开奖号码历史查询:income of a household and divide it by 12. Banks generally use the lower of the two numbers to d💙etermine how large a loan to offer you.

Special Considerations

Qualification ratios are not rigid. Excellent 澳洲幸运5开奖号码历史查询:credit history often mitigates a poor ratio, for example. In addition, some borrowers who do not meet the standard qualifying ratios take advantage of special mortgage programs offered by some banks. The added risk of default by these borrowers means they generally pay higher 澳洲幸运5开奖号码历史查询:interest rates t✤han mortgages that meet standard qualifying ra𒊎tios.

Credit Card Debt and Qualification Ratios

澳洲幸运5开奖号码历史查询:Credit card debt also counts toward your back-end ratio, but this is much more complicated. Lenders used to apply the 澳洲幸运5开奖号码历史查询:minimum payment on a credit card balance and call that monthly debt. However, that system wasn't fair to credit card users who paid off their balance in full every montꦗh and used credit cards mainly for convenience and reward points.

Most lenders now look at the borrower’s total 澳洲幸运5开奖号码历史查询:revolving balance and apply 5% of the total as monthly debt. Say you carry $10,000 in credit card 🍌debt. In this case, the bank tacks on $500 in monthly debt to your back-end ratio. 

Example of a Qualification Ratio

Here's a hypothetical example to show how qualification ratios work. Let's say you and your spouse earn a combined $96,000 a year; your family's gross income would amount to $8,000 a month. Multiply $8,000 by the 28% threshold required by most lenders, and you’ll get the minimum housing expense you can afford, which lenders call the front or 澳洲幸运5开奖号码历史查询:front-end ratio.

In this case, your family would be eligible for a loan if total monthly housing expenses do not exceed $2,240. Note this expense figure includes property taxes, homeowner’s insurance, 澳洲幸运5开奖号码历史查询:private mortgage insurance (PMI), and charges such as condo fees. 

Now, let's take a look at the back-end ratio using the same example. In this case, multiply the $8,000 monthly income by the minimum threshold of 36%. This is effectively your debt-to-income ratio, and you'll get a figure of $2,880. Next, deduct any monthly debt payments from that $2,880. Let's assume these consist of a $300 monthly car payment and a $400 monthly student loan payment. This leaves you with $2,180 for housing expenses. Note that this figure is typically lower than the front-end ratio.

The Bottom Line

A qualification ratio might seem like an arbitrary factor in determining someone's mortgage eligibility. However, it's a useful tool for seeing how much of a mortgage someone can realistically afford. Improving your qualification ratio shows lenders that you have healthy financial habits and an income that could support paying a mortgage.