Debt ratios are what banks use to qualify a mortgage borrower. Your debt ratio is what percentage of your gross income a bank will allow you to spend on a new mortgage and your existing debts.
The debts that a bank will count against you are car loans, student loans, credit card debt, the new mortgage you are qualifying for, and any other mortgage debt you may have. They do not count debts like auto insurance, utilities, cell phone bills, etc.
Fannie Mae is currently dropping there maximum debt ratio to 45% with exceptions to 50% with compensating factors. Prior to this change Fannie Mae allowed debt ratios up to 50%, and I had seen banks approve up to 55% or 60% even!
To put this into perspective, since the banks allow you to use your gross income when qualifying for a loan, and if they now will allow you up to 45% of your gross income for a new mortgage and other debt, that means they are leaving you 55% for other debt.
And other debts consist of:
federal income taxes
state income taxes
Medicare
Social Security
savings
eating out
groceries
travel
gifts
etc.
You can see how the remaining 55% would get quickly eaten up.
When I first got into the mortgage business, in 1986, debt ratios maxed out at 36% (with compensating factors you could go higher, like 40%-42%).
The real estate bubble helped to distort what banks allowed people to spend, and what people wanted to spend so that they could get involved in the “real estate game”.
Where will debt ratios go next? I think they’ll get even tighter into 2010 and beyond. Will this have an effect on home prices? Will the consumer rebel and push Congress for more liberal underwriting? Will Congress need to be pushed? Did Congress help get us into this housing mess as it was by pushing to get more and more people into homeownership? Should everyone own a home? Is renting a waste of money?
You can see where my next blogs will be headed….
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