Money & Credit - Personal Finance Blog

Your debt to income ratio has nothing to do with your credit score, but it can cause you to be turned down for a mortgage even if you have a good credit score.

Your mortgage debt to income ratio is nothing more than a ratio to show you how much of your gross income goes towards paying debt and rent/mortgage. Here is what you need to know about your income to debt ratio and what to do if you have been denied credit.

How is it Calculated
When it comes to getting a mortgage, there are two debt to income ratio calculations used. The first is called the front end ratio and it measures your percentage of income that can go towards your mortgage (payment, taxes, insurance, pmi, etc). The second ratio is called the back end ratio and it includes all recurring debts (mortgage, credit cards, car payment, student loans, etc)

Take a look at our example below using $60,000 annual income and a 28/36 debt to mortgage debt to income ratio

Yearly gross income is $60,000/12 = $5000 monthly income

Front-end Ratio – $5000 x .28 = $1400
Back-end Ratio – $5000 x .36 = $1800

Using our example above, a total mortgage debt to income ratio of 36% would allow for up to $1800 in debt (including mortgage) and your total mortgage payment could not exceed $1400 per month.

Current Ratio Limits
Different mortgages have different mortgage debt to income ratio requirements and they are listed below

Conventional Mortgage – 28/36
FHA Mortgage – 31/43
VA Mortgage – 41/41
USDA Mortgage – 29/41

What is a Good Ratio
While some will go as high as .41 (dangerous levels), most banks want a mortgage debt to income ratio of .36 or lower. At the end of the day, the lower your debt to income the better and this should be your ultimate goal in life and not only something to think about when trying to get a mortgage. Think about it, you keep more of your money every paycheck and you are not stressed about debt.

What to Do if Your Mortgage Debt to Income Ratio is to High
The only thing you can do is pay off your debt. Get rid of student loans, credit cards, etc. One trick you can try is if your  mortgage debt to income ratio is denied and you want to get approved ask about lowering you car payment since doing so may bring your ratio down. If they give they agree, then you can either refinance or trade your car in for a lower priced car. Assuming your not upside down on the loan or you can get the loan financed long enough, you could drop your payments by $100 or more and in return drop your ratio.

Starting on July 21, 2011 you will be able to receive a free credit score if you are denied a credit card, student loan or auto loan. While this is a good step in the right direction, how about getting a free credit score regardless of if you apply for something or not and why are we limited to only credit cards, student loans and auto loans? What about mortgages, employment, etc? Anyways, here is what you need to know before the new laws become effective

A Free Score May Not Be Bad News
Don’t stress if you get a credit score in the mail. Some lenders may choose to send all applicants their score because this is an easier way to stay compliant with the new laws and you may get the score before the approval or denial letter.

You May Still Need to Purchase Your Score
If you have a large purchase coming up, knowing your score before hand could alert you to possible problems and give indications on what you can do to increase your score so it will be as high as possible before applying. Experts recommend getting your score 2 to 3 months before making the purchase so you have time to react to negatives if needed.

Get The Right Score
There are several versions of the credit score and you need to make sure your getting the right score. The new laws require that you get the exact score used. So if it is proprietary or another special score type, you have to know the same exact score they used to make their decision.

If your interested in a free credit score, try CreditKarma.com. This site will give you an actual free credit score and will give you a general idea of where you stand.

HSBC is talking about getting rid of its US credit card arm. This would include the retail cards and unfortunately the popular (as well as the best) bad credit credit card issued under the brand Orchard Bank leaving some very bad choices for consumers who need to build or rebuild credit.

HSBC has been in the process of trying to sell their credit portfolio since May, but it appears there are very few interested parties at this time and according to CEO Stuart Gulliver, HSBC might shut down its US credit card arm if unable to sell its portfolio

So what does this mean for those with bad credit who need a credit card? As it stands now, Orchard Bank has been serving as a life line for those who are under-banked and the closing of this arm of their business could leave a huge gap for those in the sub-prime credit market. The choices are going to be abysmal at best and the best card at this time to replace it would be the Merrick Bank credit card. The fees are going to be more and the customer service is lacking, but given the choice of Merrick Bank and Applied Bank,  First Premier or Continental Finance, Merrick is the clear winner.

One of the hottest issues in our current economy and the upcoming elections is how to fix social security. At the current rate of spending (paying benefits) and the lack of funds to cover the payments, our social security system will be bankrupt. So how do we fix the mess we are in?

Well, I am not an economist or a financial wizard of any means, but I see that there are three problems that need to be addressed.

1st – Raise The Tax Cap – Right now the tax cap is set at $106,800 and this means that your only taxed for the 1st $106,800 you earn. The problem is that this is not enough and we basically need to get rid of the cap. Everyone should pay the social security tax just like everyone pays the federal income tax.

2nd – Reduce or Limit Benefits – As bad as it sounds, we are going to have to reduce or limit the amount of benefits given to retirees. A better way would be to cap how much you receive based on how much you earned like the unemployment tax. No matter how much you earned your capped at a certain amount set by the states. For example if you live in Minnesota the max you can collect on unemployment is $578 per week no matter how much you earned or payed in. We need something similar in place for social security with the only exception is that there will not be any limit of the weeks you can receive benefits. Need more, start funding a Roth IRA or learn to live within the means you have. Sounds harsh, but this is the way it will have to be.

There is a problem. What about people who have not worked? Well unless you can prove mental retardation or permanent disability, if you did not work to pay in, you do not get anything. Harsh yes, but why should people get a free ride.  If you have not worked, why should you be able to retire with any benefits. From what I can see, your whole life has been a retirement.

3rd – Hands Off -  Simple as that, if we pay the money for our social security then our elected officials need to keep their hands off our money. Maybe we need to have an account set up for each American and have our share added to our account each month or something similar.

Bonus – Opt Out Availability – While this would not fix the issue, I would rather take a loss now on what I have contributed so far and be able to opt out of social security all future deductions and payments and have my money deposited directly in to my Roth IRA or similar account. Why, the Government has proven they cant manage money so let me take it on myself and actually make money.

As I said earlier I am not a economist or financial expert and my solutions may be flawed, but we need a solution and our current (and past) administration seems to think that we can spend our way in to fixing everything and this is going to destroy our financial system.

According to the Wall Street Journal, nearly 40% of consumers who borrowed against their homes are underwater. The article shows the importance of not borrowing against your home and the problems that it can cause if something goes wrong. While some used money for emergencies or medical bills, others used the money to get new cars, vacations, etc and now it is coming back to bite.

For banks, the problems are daunting. “The implication is that there are still a lot of people who are at risk of default, so delinquency and default rates are going to reflect that large amount of negative equity for some time to come,” said Jan Hatzius, chief U.S. economist for Goldman Sachs Group. This is bad, because the risks extend beyond the borrowers to banks due to the fact that second-lien mortgages are heavily concentrated on bank balance sheets. Unlike the original mortgages that were packaged and sold to investors, no one wants to take the second mortgages so the bank has to hold them.

For consumers (even those not having problems) the problems are just as serious and arise because second mortgages make it more difficult for troubled borrowers to negotiate loan modifications with lenders. Borrowers then end up walking away and ruining their credit and then pass the problem back to the bankers and in the end, you and I. It all comes back full circle and affects us all more than we know.

This is an important lesson for those in their homes or thinking about buying, do not use equity in a home for anything. Work towards paying off your home and becoming mortgage free. Get the home paid for, then buy the Lexus or Harley. Be responsible and it will pay off big time in the long run. You can read the complete article here.