Qualification ratios are limits set by lenders to state the maximum housing expense to income ratio, and total debt to income ratio in order a borrower can have in order to qualify for a loan.
Definition: Qualification ratios are requirements set by the lender stating what the maximum allowable housing expense to income ratio, and housing expense plus other debt to income ratio can be in order to qualify for a loan. Many lenders use a 28% housing expense to income and a 36% housing expense plus debt to income ratio. Other ratios lenders use may involve how much you put down on a home, or the loan-to-value ratio.
Qualification ratios refer to the percentage of your income that is taken up by your debt obligations. Lenders look at this percentage to help them decide whether or not you are a credit risk.
When you request a mortgage, lenders look for certain defining financial characteristics about you. For example, they will want to see that you have a history of full-time employment. Also, they like to see that you have a good credit score. Lenders also look for certain qualification ratios. In most cases, your monthly mortgage payment should be no higher than 28 percent of your total monthly income. This percentage includes the monthly principal, interest, taxes, and insurance (PITI). You should also have no more than 36 percent of your total income needed to pay your total debt, including your monthly mortgage, credit card and other loan payments.
If the mortgage you are requesting would cause your monthly debts to exceed 36 percent of your total income, you may have more difficulty being approved. The lender is likely to decide that the loan is too great of a credit risk. There are, however, situations in which your qualification ratios do not matter as much to the lender. If you are putting down a sizeable down payment, even greater than 20 percent, the lender may not care as much about the qualification ratio since you will have so much of your money already invested in the property. That makes you less likely to default on the loan.
Qualification ratios can be a good reality check when applying for a mortgage. It is not a good idea to put undo financial stress on oneself by acquiring too much debt. The credit ratio lets you know just how much of your income is required to pay your monthly debt obligations.