Loan Officer Training 09/17/2024 - How to Calculate Debt-to Income Ratios

Welcome to Loan Officer Training! In this episode, we’re diving into one of the most crucial metrics in lending: the debt-to-income (DTI) ratio. Understanding and accurately calculating DTI is essential for assessing a borrower’s financial health and their ability to manage additional debt.

Join us as we break down the process of calculating DTI ratios step-by-step. We’ll cover the formula, discuss how to gather and interpret financial information, and explore the impact of DTI on loan approvals and terms. Our expert hosts will share practical tips, common pitfalls to avoid, and real-world examples to illustrate how DTI ratios play a vital role in the loan application process.

Whether you’re new to the field or looking to refine your skills, this episode will provide you with the knowledge and tools you need to effectively evaluate borrowers’ financial situations and make informed lending decisions.

Tune in to Loan Officer Training and enhance your expertise in calculating debt-to-income ratios to better serve your clients and excel in your role as a loan officer.

Join The Mortgage Calculator at https://themortgagecalculator.com/join

About The Mortgage Calculator:

The Mortgage Calculator is a licensed Mortgage Lender (NMLS #2377459) that specializes in using technology to enable borrowers to access Conventional, FHA, VA, and USDA Programs, as well as over 5,000 Non-QM mortgage loan programs using alternative income documentation! 

Using The Mortgage Calculator proprietary technology, borrowers can instantly price and quote thousands of mortgage loan programs in just a few clicks. The Mortgage Calculator technology also enables borrowers to instantly complete a full loan application and upload documents to our AI powered software to get qualified in just minutes!

Our team of over 350 licensed Mortgage Loan Originators can assist our customers with Conventional, FHA,

Catch all the episodes of the Loan Officer Training Podcast at https://themortgagecalculator.com/Page/Loan-Officer-Training-Series-Podcast

Catch all the episodes of the Loan Officer Training Podcast at https://themortgagecalculator.com/Page/Loan-Officer-Training-Series-Podcast

Loan Officers for Unlimited Free Non-QM Leads & Trainings Join The Mortgage Calculator at https://themortgagecalculator.com/join

The Mortgage Calculator is a licensed Mortgage Lender (NMLS #2377459) that specializes in using technology to enable borrowers to access Conventional, FHA, VA, and USDA Programs, as well as over 5,000 Non-QM mortgage loan programs using alternative income documentation!

Using The Mortgage Calculator proprietary technology, borrowers can instantly price and quote thousands of mortgage loan programs in just a few clicks. The Mortgage Calculator technology also enables borrowers to instantly complete a full loan application and upload documents to our AI powered software to get qualified in just minutes!

Our team of over 350 licensed Mortgage Loan Originators can assist our customers with Conventional, FHA, VA and USDA mortgages as well as access...

Transcript

Restream recording Sep 17, 2024 • 04:04:42 PM: 0:13

So welcome everyone. My name is Kyle Hiersche. I'm the COO of the Mortgage Calculator joined here by our president Nick Hiersche and our CSO Jose Gonzalez. We are a lender that specializes in non QM loans and what we do every Tuesday, Wednesday, and Thursday at 12 p. m. Eastern is our loan officer training series. We do a deep dive into a different loan officer training topic and today's topic is going to be some back to the basics of how to calculate debt to income very important for every loan officer to know. So We'll let Jose with 29 years of experience, break it down for us. So go ahead, Jose. Good afternoon, everyone, or good morning, depending where you're located. Uh, today, uh, it's a little bit back to the basics, right? How to calculate that to income ratios. But what we're going to be talking about here is not really the specific equations, but the components, right? I mean, anybody can plug numbers into an equation. But the important thing is what are the numbers that you plug in, right? And which ones are included, which ones are excluded, what do we mean by contingent liabilities, all these factors that is really the, um, Really important, uh, issues to consider, right? Because the actual calculation is pretty simple, right? You just get the expenses and income divide, and you're going to get a proportion of the borrower's income that is being applied to, you know, being used to pay those debts. That's really what debt to income means. So let's go right into it. break it down for you so that you all know exactly the numbers to use. So, uh, debt DTI, also known as debt to income, is calculated by dividing the debt service by the monthly income, right? Now what we mean by debt service is going to depend on which ratio you're actually trying to calculate, right? We have the front end ratio, that's also known as the housing expense ratio, that calculates the proportion of a borrower's personal monthly income that goes towards the total housing expense. Then we have the total debt ratio, which is a proportion of a borrower's personal monthly income that goes towards the total housing expense, PITI, and association fee. I'm going to get that into the next slide. Plus, Other debt service. So total debt ratio includes your housing expense, plus the other debt service that is applicable to be included and not excluded, right? The excluded items obviously are not included. DTI is a key factor in the risk assessment for mortgage approval. When borrower income. Is being considered, uh, please note that, uh, I do men make a mention there. We're talking about borrowers, personal monthly income. What do we mean by that? We mean whatever income transfers from their business tax returns and any other place where they're gathering income. It all goes. Either to a tax return or to a W 2 and pay stubs, whatever is the borrower income type that you have. A profit and loss report that eventually goes to the borrower personal income. Bank statements that eventually go to the borrower personal income. All roads when using DTI eventually end. With the borrower's personal income, which is then used as one of the components to calculate the debt to income, right? You have a debt component and then you have the income components. It's very important to know we're talking about the borrower's personal income. Obviously, uh, DCR, DSCR loans do not consider DTI. As they utilize property rental income rather than borrower personal income, which is why DTSCR loans are a great workaround for when you have DTI issues on investment properties. Like I was mentioning, as DTI being a key factor in risk assessment. If the DTI is higher, the, you know, that will affect loan terms, right? Like the, the rate, the cost of the rate, you see it all the time, or the borrower just may not qualify. If the non QM says the maximum 45 DTI, there's no automated underwriting on that. That's it. That's a hard stop. So do be aware how Incorrectly calculating DTI could, uh, result in, um, unwanted, um, issues needlessly. So what are the components of DTI? Well, we did mention always use borrower's personal income. Do not use non debt expenses. in calculating DTI, like auto insurance and cell phone bills, right? We're, we're only talking about debt service here. Uh, but if you have a W 2 borrower, that's doesn't matter if they're self employed, if they're hourly, if they're salaried, if they receive a W 2 and they get deductions on their pay stubs, you will use their gross. income. Now, if it is a self employed borrower, you will use their net personal income that they report on the 1040, right? You'll do your income calculations, actually, is really what you'll do. You'll do your income calculations and you'll get a net income amount for that borrower after considering whatever components of the income if they're, if they have a corporation, an S corp, you're going to use their 1120s plus their 1040 and completing the income calculation worksheet, you're going to get the net income. And then that's what you're going to use for the income part of the equation. So you see two different approaches there, depending on if they're W 2 or self employed. Now, the components that are included in the housing expense ratio, you're looking at principal, interest, tax, insurance, uh, and as applicable, mortgage insurance and homeowner's association fee. All of those, uh, make up the housing expense ratio or otherwise known, uh, also known as the, uh, Front end ratio, and then you have your total debt ratio, which is the housing expense components. We just covered above plus credit card payments or and revolving debt in general auto loans student loans And any other recurring notice, we're talking about debt and we're not talking about expenses. So what are the, um, additional liabilities to be included in DTI, right? These are items that may not be as obvious. They may not be. On a, on a credit report. And if they are on a credit report, maybe they're reporting a zero payment due. But we all know that that's not the case. We wouldn't usually put zero unless it's actually zero. So for example, now, these are some of the ones that you may not have considered. And these are the ones that end up causing. Errors and DTI calculations and not just somebody not knowing how to work the equation is just putting in the right components in there. So we're looking at, for example, alimony. child support and separate maintenance payments under a divorce decree, separation agreement, or other legal agreement when they continue for more than 10 months, right? So that's the key. 10 months is the threshold there. If any of those agreements show that the borrower's liability under that agreement Is less than 10 months, then it can be excluded. If it is 10 months or greater, then you have to include it. And we all know, uh, for example, alimony doesn't appear on tax return. I mean, on a credit report, child support will only appear in a credit report. If there is some type of a court order. And neither will any type of separate maintenance payments under any type of separation agreement. Those were all items that we would have to obtain from the borrower after determining if they're separated or if they are divorced. Deferred installment debt. And here we're not talking about student loans. We're talking about just deferred installment debt. Like, for example, I had one that came across my desk the other day where their, their auto loan is deferred. So this, this requires copies of the payment letter, meaning, you know, if there's either the normal statement. What they would be paying, or if there's any kind of a payment letter that can be obtained from the loan servicer, uh, to determine a payment, a current payment amount, what it would be if they add, once they're out of forbearance or an actual copy of the forbearance agreement that may state what the payment would be when they get out of forbearance. All of these things are necessary, you know, not all, but one of these components are necessary in order to be able to determine what the payment would be should the borrower. be making the payments because you have to include that liability that's not being paid in the DTI calculations. Next one we're talking about here is federal income tax installment agreements. As long as there is not a lien filed. If there's a lien filed, the tax lien, then that tax lien, uh, if it's a DTI loan, That tax lien will have to be satisfied at or before closing, but if there is no lien and they are, and they have a repayment plan with the IRS for their tax liability, then you would just include the amount in the payment plan. It's a monthly payment into their liability. Garnishments with more than 10 months remaining. That would be a wage garnishments. That's something that you usually find, uh, somebody gets divorced. There's a court order, uh, of, of some type and pay stubs show deductions for some type of garnishment on their, uh, from their income. Well, there's 10 months or more remaining that will continue to be, uh, considered a liability, even though, like you can see, it's not on a credit report anywhere, but it is something to take into consideration if it is applicable. Now, this is a common, um, one that catches a lot of people off guard. Lease payments, right? Usually it's auto lease payments, cannot be excluded even if they have less than 10 months remaining. Lease payments are not considered an installment account. They're lease payments. And the logic there is that that auto lease will probably need to be replaced with a new auto lease as soon as that lease expires. Um, and unless they do something, they do some other kind of a scenario or maybe prove they have another car that that's the one that they're going to use. Uh, they're just going to hit you for the lease payment, regardless of if it's one month. Um, housing expense for non occupant co borrower also has to be included in the liabilities, right? This is very important. That, uh, non occupant co borrower could be renting, uh, wherever they live or, you know, You know, could be on their credit report because they own it. You have to make sure that you include that housing expense in the overall DTI calculations. And then we, I alluded to deferred student loans. Uh, so yes, for deferred student loans, we, even though they may not state a payment amount, we do have to include a payment in the application. If it's Fannie Mae, Uh, loan you're looking to close, it's 1 percent of the, of the balance of the student loans. That's the monthly payment. And if it's Freddie Mac, it's half a percent. Of the balance. Now this is not applicable. Neither. Neither of these two are applicable if the borrower is actually on an income based repayment plan and you have a letter from the loan servicer stating that they are an income based repayment plan and stating the amount of the payment. If it's zero based on an income based repayment plan, then it's zero. Uh, an income based repayment plan is not the same as a deferred student loan. So these are pretty interesting items, uh, and the ones you have to include. And now in our last slide here, you see our happy borrower there because his MLO knew what to include and especially knew what to include. exclude because these are very interesting items here that aren't always obvious. First one, which is related to somebody who may have gone through a divorce, this is a common one, when there is a court ordered assignment of That would be, for example, the divorce decree says that, uh, Mr. Smith is the one that's going to stay with the property and be responsible for the property because he's buying out the soon to be Mrs. Smith's interest in the property. Uh, so, uh, from the point of the date of the, of that assignment moving forward, uh, the creditor. Uh, does not have to, uh, include that liability that could be excluded from the DTI calculations. So that's really important. We've seen that a few times. Especially important is, uh, and, and obviously this is when the creditor does not release. this borrower from liability. Now, this is especially important, not only in excluding the contingent liability, which is what that is called, but it is also important to note that the payment history of this debt will not, cannot be considered against the borrower for purposes of Of, um, underwriting now, however, what may happen though, is if that loan is currently being unpaid, the, uh, this, uh, this borrower's credit score is going to be affected. And that does not have that, that does not have anything to do with excluding the liability from the DTI that has to do with the credit repositories and what they're putting. And that could definitely affect your borrower's ability to qualify. Do note that the court ordered assignment of debt, whatever monthly payment would be due from that, uh, cannot be considered against the borrower. Loans secured by financial assets also can be excluded. What are we talking about? For example, borrower wants to close, he's gonna, he's going to use a loan from their own 401k plan. Basically they are pledging their 401k retirement assets To get a loan from their 401k and then they're going to pay it back to the 401k. Anyway, you look at it, that's a secure loan, or maybe they have some stocks out there and they're pledging the stocks to get a loan. That's a secured loan. Both of those options would be secured by financial assets. So you do not have to include the monthly debt service for that 401k loan. Open 30 day charge accounts. The most common one being American Express. Uh, these can be excluded. The monthly payment can be excluded, but please do note that a reserve requirement, uh, may be needed to offset the balance. That's going to depend on if it's an overlay from that investor or not. What do I mean by that? Okay. Current balance and the American express shows a 9, 000. Okay. And then it shows a payment of 9, 000. Do okay. You can exclude that as long as. If they were to put this overlay and I just had this, uh, requested on a loan on a HELOC. That we are processing where they said, sure, we can exclude that. As long as a borrower has enough assets to cover, she didn't need to be paid. So do look for the guidelines or overlays for wherever the loan is going to make sure how they treat the open 30 day charge accounts, non mortgage debt paid by others can be excluded. Now, the important point here is, Non mortgage debt, right? That means everything else other than, uh, housing expense, the PATI, uh, can be excluded whether or not the other party is obligated to the, on the debt. That means you have a, you know, a car loan in your name, you, you were the co signer for your, for your brother, let's say, your brother's not on the loan. Obligated to the loan. Only you are. Well, that's okay. Because unless your brother is one of the purchasers, Or the borrowers, let's say, unless he's one of the borrowers on the loan, which would make him a party to the deal, or unless he's the seller or the buyer, whatever it may be, if he's not a party to the deal, it's fine. If he is a party to the deal, then you cannot exclude that liability. But the important point here is non mortgage debt, whether or not the other party is obligated on the debt. Can be excluded. You would have to show most likely your last 12 months proof of payment of the debt to be able to exclude it and make sure that there's, there aren't any, um, late payments as well. The account is not delinquent, but let me state the items that, you know, the examples besides the obvious, right? The obvious one would be an installment loan, like a car loan, but do you know, this is also applicable for student loans, revolving debt, lease payments. alimony and child support. Any of those, um, items there, if they are paid by someone other than the borrower, you have the last 12 months, they can be excluded from the liability. And the last category here, the last liability that can be excluded is mortgage debt paid by others, as opposed to non mortgage debt. This one is mortgage debt, the housing expense. Now, please note the first bullet point there states that, uh, if the party making the payments is obligated on the debt. So you're on the loan for the house, your brother is not on the loan for the house, your brother's making the, the, the payments for the house loan, you have the last 12 months, you have no delinquencies, rental income is not being used to qualify. However, Since your brother is not on the loan, I'm not obligated on the loan for that home. You cannot exclude the debt, right? He has to be obligated to the debt in order to be able to exclude it. Uh, if it is a mortgage debt paid by others. So I hope that these are helpful here, and I'm pretty sure that they will be because, um, I know that, uh, not all of these were, um, items that you were aware could be excluded, nor the items that you were aware could probably be excluded. Included, right? This is definitely not, uh, the obvious issues. And, um, so do always make sure to check the guidelines though, if it's non QM of the loan that you're looking to originate to make sure that their guidelines are in line with these here, which I basically obtained from the Fannie Mae and Freddie Mac selling guide. All right. Thank you, Jose. Great stuff there. I don't see any questions, actually. But, uh, definitely great back to the basics training there. So, uh, we do have some more great, uh, basic trainings here this week. Remember that we do this at, uh, Oh, comment coming in. Oh, just a comment there. Uh, remember that we do this at 11 or excuse me, at 12 PM Eastern time, every Tuesday, Wednesday, and Thursday. So we will see you all tomorrow with a new topic to go over for the next episode of the loan officer training series with the mortgage calculator. Have a great day.