Most people find bank underwriting guidelines to be very confusing. When many apply for loans, they are filled with self-doubt and questions as to whether they will be approved or not. The single most important factor in determining whether a borrower qualifies for a loan is arguably not the borrower’s credit history or the collateral value. Most lenders feel the borrower’s ability to pay is the single most important factor that goes into the loan approval process. At the center of this question is the ratio of the borrowers debts in relation to their income which is called Debt to Income Ratio (or DTI) on consumer loans for Debt Service Coverage Ratio (DSCR) for commercial deals. Many, however, find the formula a mystery. Let’s demystify it by first looking at what debts are included in the calculation:
The New Loan: The debt ratio calculation must always start with the new debt that the borrower is applying for. The new payment must be added to the ratio calculation.
The Old Mortgage: Unless the borrower is selling any old properties that they own in favor of the new property, you much include the old loan or mortgage payment in the calculation.
Rents and Leases: Is the borrower leasing or renting property or equipment? These payment are most certainly part of the debt to be included in the ratio.
Real Estate Taxes: Real Estate Taxes for all properties, including any new property that is being acquired, should be included. If you are calculating a monthly Debt to Income Ratio, you’ll want to take the annual tax amount and divide it by 12 to compare apples to apples. For an annualized calculation like Debt Service Coverage Ratio, you would use the whole annual number.
Insurance on Real Estate: Similar to taxes, insurance premiums on all real estate owned by the borrower, including on any new property being acquired, should be included in the calculation.
Car Payments: Regardless of whether the borrower has a car loan or an auto lease, the payments are included.
Student Loan Payments: Nope, student loan debt is not left out. You must include the payments for all student loans in the calculations.
Credit Card Payments: Credit cards and any revolving line of credit can get tricky for borrowers. May borrowers feel that they should claim a much higher payment on their credit cards to show the bank that they are paying it down faster. That is the wrong approach. Banks want to see what your required minimum payments are on the line, not what you actually pay. If you pay more than the minimum and want the bank to take that into account, it’s not going to help you. Only report what the minimum required payment is. That’s what the bank is looking for and it will help your ratios.
Installment Loans: Installment loans are any type of loan where you pay the loan back with a payment that is typically fixed and over a specific period of time. For instance, you borrow $5000 from a lender to fix your vehicle. They have you pay the loan back over 36 months of $X per month. That is an installment loan as it is paid in “installments” and it is, indeed, included in the calculation.
Child Support, Alimony, and Separate Maintenance Expenses: I’m sure you’ve read the verbiage at the bottom of a loan application that states that you don’t have to disclose income from alimony, child support, or separate maintenance as part of the income side of the calculation, but you are required to report any of it that you are paying. Those payments are included in the ratios.
Back Tax Payments, Collections, and Judgments: If you have collections or judgements, there is a good chance that the lender will deny you for having delinquent credit obligations, but any payments that you are required to make for back taxes, collections, or judgments will normally count against you in calculating your debt.
We’ve talked about what payments are included, but what is excluded in the calculation? Utility bills are normally not taken into account, so you usually don’t have to worry about your phone, electricity, gas, and cable. You won’t usually report gasoline, entertainment, or groceries either. Some lenders will include “lifestyle payments” in the calculation where they will throw in a number that is usually a percentage of your income to cover these things. It’s not something we normally see in consumer lending, but some commercial lenders do throw this in the calculation.
I’m sure we’ve missed touching on some items. If so, email us thought our contact page and we’ll do our best to answer the question. Stay tuned for another article on the income side of the calculation.