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Minor Changes Yield Major Benefits With Debt Ratios

Some nontraditional ways to reduce debt ratios

May 1, 2001

By Sam Garcia

Mortgage loan applicants with high debt ratios can find many mortgage loan programs that will accommodate this higher risk factor. However, when the required down payment or interest rate is more than the applicant will accept, originators, processors and underwriters search for ways to modify the transaction that enable the applicant to close on a home purchase.

The simplest way to reduce the debt ratio is to require a larger down payment. Another option is to require that debt be paid off. A less popular option may be to require applicants to lower their sites and purchase a less expensive home. During periods when mortgage rates are higher, adjustable rate mortgage programs may offer some relief.

However, if none of these are workable options, some of the following moves may make a difference.

Move Debt To Income
Depending on the underwriter, it may be possible to convert what is currently considered a monthly payment to a negative income. For instance, if child support is automatically deducted from an employees paycheck, then reduce the gross income by the amount of the child support payment and remove the payment from the debts. Following is a rental property example of how the debt ratio is affected by moving the payment from debts to income.

monthly Gross Wages $5,000
monthly PITI mortgage payment on primary residence $1,000
monthly revolving and installment payments: $1,000
monthly rental income: $1,000
monthly PITI mortgage payment on rental property $1,000

traditional calculation
move debt to income calculation
    monthly income:

wages $5,000
rent $1,000

total $6,000

    monthly payments:

payment on residence $1,000
revolving/installment $1,000
payment on rental $1,000

total $3,000

$3,000 / $6,000 = 50%

    monthly income:

wages $5,000
rent $1,000
payment on rental <$1,000>

total $5,000

    monthly payments:

payment residence $1,000
revolving/installment $1,000

total $2,000

$2,000 / $5,000 = 40%

Audit Statements
In some cases the credit report may indicate a payment that is greater than what is showing on the applicants monthly statement. Review each statement -- directly or over the phone with the applicant -- for the minimum monthly payment. Make sure that you have deducted any past due payment, since this is in excess of the regular or minimum payment. You should be able to present to an underwriter statements that prove a lower payment than reported on the credit bureau.

Reduce Down Payment
In some cases applicants may qualify for a lesser down payment than they are making. For instance, maybe they qualify for a zero down payment but were intending to make a five percent down payment. What might make more sense with a high debt ratio applicant is to utilize the funds for paying off debt instead of making a down payment. Because a typical credit card payment is based on a short-term amortization, carrying an equal amount of thirty-year mortgage debt costs much less monthly. In addition, mortgage debt is usually at a much lower rate than credit card debt, and it is tax deductible.

Raise Purchase Price
In cases where the appraised value exceeds the purchase price, a buyer can re-negotiate a higher purchase price where the seller pays closing costs. For instance, if a contract has been accepted at $100,000, but the appraised value is $105,000, the applicant may be able to re-negotiate a $103,000 sales price where the seller pays $3,000 of the buyer's closing costs. While this has the effect of financing the closing costs, the applicant would have an additional $3,000 to apply toward debt ratio reduction.

Maximize Funds Used To Pay Debt
Which bills you direct the applicant to pay off can have more effect than how much they payoff. For instance, an old car loan with a $5,000 balance and a $400 monthly payment would reduce the debt ratio more than paying off a $10,000 credit card with a $250 minimum monthly payment. A simple way to analyze which balances will have the greatest effect on the debt ratio is to divide the monthly payment by the respective total balance. Do this with each debt, then start paying off the balance with the highest ratio. In the example above, the car loan payment would be better to eliminate because it is 8% of the balance, whereas the credit card payment is only 2.5% of its respective balance. This process can be used until no funds remain for paying off debt.

Sam Garcia has been in mortgage lending since 1980, and is managing editor of MortgageDaily.com. He also owns and operates CloseNow.com, a real estate portal site.

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