Debt to Income Ratios (DTI) – Their Importance for Loan Modification

Secrets to Qualifying for a Loan Modification – DTI

In the loan modification process, the front-end debt-to-income (DTI) ratio is probably one of the most important qualifying factors. Understanding this concept and how it applies to your unique circumstances can greatly increase your chances of being approved for home loan modification. Why is this? When your bank is analyzing your loan for a modification, they focus on some important ratios in determining whether or not to approve or deny your Loan Modification Application. These ratios are important because the bank uses them to determine your new target payment, which is based on a percentage of your gross income. If a modification is viable and the bank agrees to modify your loan, the bank needs to see convincing evidence of the fact that you could realistically afford to cope with the new target payment. However, if a target payment is not sustainable based on the defined DTI (be it 31% or 42%), this will greatly impact your chances of approval.

Front-end Debt-to-Income (DTI)

According to President Obama’s foreclosure prevention plan known as the HAMP program, the statement is made that in order to qualify for a HAMP, the bank must conduct income documentation, also known as income validation. The bank needs to confirm that the homeowner’s/borrower’s monthly mortgage payment (PITIA) ratio is greater than 31 percent of his/her gross income prior to the modification. This ratio is called Front-end Debt-to-Income(DTI). If it is lower than 31%, then the borrower is not considered eligible because a case for financial hardship cannot be sufficiently made. What exactly is your house mortgage payment or PITIA? It is comprised of principal, interest, taxes, insurance, and association dues. PITIA excludes mortgage payments on second or third liens. What exactly is a front-end debt-to-income in the context of loan modification? It isthe monthly mortgage payment divided by the borrower’s monthly gross income. These terms may seem a little daunting to someone who is not familiar with the mortgage and home loan modification business, but they really are not as nasty as they may appear once you understand the concepts they refer to.

What is an affordable house mortgage payment as the target with HAMP?

It is further stated in the HAMP plan that an affordable house payment subsequent to the modification process should not exceed 31%-38% of the homeowner’s front-end DTI. What this means is that the mortgage payment comprised of the principal, taxes, insurance, and association fees (PITIA) on the initial home loan cannot be higher than 31%-38% of the family’s monthly gross income. Based on the Obama foreclosure prevention plan, if other liens exist against the home (a home equity line of credit or an additional mortgage, for example), these liens are factored in separately as a portion of the back-end DTI.

Suggested Front-End Debt-to-Income For HAMP & Private Loan Modifications

  • For HAMP – According to HAMP (Home Affordable Modification Program) guidelines, the front-end DTI ratio needs to fall between 31%-38% once the modification process is complete.
  • For Private Loan Modifications – When dealing with private mortgage modifications, there is room for this ratio to fluctuate at the lender’s discretion. The relevant range in these cases is 31%-42%.

Focusing on Back-End Debt-to-Income

The back-end DTI is calculated based on the sum of all monthly payments related to debts. The suggested back-end DTI is determined by utilizing your newly decreased mortgage payment (the combination of the principal and the interest) once your loan modification has been completed, in addition to all of your pre-existing monthly debt obligations.

Homeowners who qualify for a loan modification based on the HAMP parameters, but whose back-end DTI subsequent to the modification is more than or equal to 55 percent, will be sent a letter that states that they need to consult with a counselor who is HUD (Housing and Urban Development)–approved. In addition, the modification will not become operational unless borrowers sign a statement which confirms that they agree to obtain financial and/or debt counseling.

Why are your Debt-to-Income Ratios Important?

Because a loan modification approval process is heavily based on financial qualification. Lenders utilize DTI ratios as decision-making tools (or indicators) to determine your ability to pay your debt. These ratios have to be within certain limits in order to avoid the risk of default, and to ensure that the borrower is not over-extended by his/her expenses and debts. Because these ratios play such an important role in the loan modification approval process, it is a good idea for you to understand them and consequently to be more empowered to make informed decisions that serve you and your family well.

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