Qualifying Ratios
Candlefocus EditorQualifying ratios are numbers used by creditors and lenders to judge somebody’s financial capability for taking out a loan or other similar long-term borrowings. It is a mathematical formula used to determine “ability to pay,” which is essential for lenders to evaluate potential borrowers. Generally, there are two qualifying ratios widely used- debt to income ratio and housing expense ratio.
Debt to Income Ratio
The debt-to-income ratio is a widely used qualifying ratio to judge someone’s financial standing and capability. It is calculated by dividing the total monthly expenses (including all debts) by the gross monthly income, before deductions. Generally, lenders prefer to see a debt to income ratio of below 36%, because it is more indicative of an individual’s financial standing and success over the long-term. A ratio of 36% or below indicates that someone is doing well financially, while ratios higher than that can give lenders the impression that the individual may struggle making payments over time.
Housing Expense Ratio
The housing expense ratio is another widely used qualifying ratio for those trying to get a mortgage. This qualifying ratio is represented by the percentage of housing related expenses, such as the mortgage loan, property taxes, homeowners insurance, etc., divided by the gross income of an individual. Generally, a housing expense ratio of 28% or less is desirable. This percentage indicates that an individual is likely to be able to comfortably pay the mortgage on a monthly basis without putting any financial strain on them or damaging their savings or other financial goals.
Qualifying ratios are an essential tool for creditors and lenders to assess the potential borrowers. Lenders prefer individuals with lower debt-to-income and housing expense ratios, as it gives the lender more assurance of their customers’ ability to pay in the long-term. It is important to keep in mind that applicants should not exceed the desirable qualifying ratios to ensure a successful application process.