There are three ratios lenders use when they review your mortgage application. One relates to the equity in your home. The other two are related to your debt. We’ll get into each of them here.
Loan-to-value ratio. This is how much you are borrowing from your lender relative to how much your home is worth.
Let’s say that you plan to purchase a home with an appraised value of $100,000. If you are putting down $20,000, or 20% of the purchase price, you would be borrowing $80,000, or 80% of $100,000. Your equity position in the property is 20%.
With some lending programs (often with conventional loans), the more you put down on the property, the lower the interest rate you can get. This is because should you default and the lender has to sell the property, the likelihood is higher that they will recoup their investment.
Lenders look at two debt ratios. They are called the front-end and back-end ratios.
Front-end ratio. In simple terms, this is how much your housing expense costs you each month compared to how much you make. To be clear, your housing expense includes your mortgage payment, property taxes, homeowners insurance and association dues, if you have them.
Example: If your housing expense is $1,000 per month and your income before taxes is $4,000 per month, your front-end ratio is $1,000 / $4,000 or 25%.
Back-end ratio. Continuing the above example, if you add to your housing expense a monthly car payment of $400, your back-end ratio becomes ($1,000 + $400) / $4,000 or 35%. Minimum ratios will vary among loan programs.
When you finance again, call or email me, and I can help you calculate your equity and debt ratios on your home buying or refinancing journey. I am always here to assist and make the process as smooth as possible.