Saturday, May 10, 2008

Do Ratios make sense for Underwriting?

A former colleague of mine (who is not on the record) at Freddie Mac says that using ratios to do mortgage underwriting makes little sense; that lenders should focus on residual income after debt service instead.

Consider two households, one of which earns $30,000, the other of which earns $100,000. If the first household pays 25 percent of its income for housing, it has only $22,500 gross income left over for everything else. Of the $100,000 household pays 30 percent of its income for housing, it has $70,000 of gross income left over for everything else. Clearly, the first households is under more financial stress, and is at greater risk for delinquency than the second. And yet lenders persist in using ratios to determine who gets mortgages and who doesn't.


Austin Kelly said...

VA has used the residual income approach since at least the 1980's (I'm guessing since they started in 1944, maybe?). It's worked for them.

sweepstakes said...

Thanks to the owner of this blog. Ive enjoyed reading this topic.

davelindahl said...

Once you've found the unreal Dave lindahl scam real estate asset you plan to make over, protected the loan. Don't ignore to characteristic in the cost of the necessary upgrade. You will generally need more money than you expect investing on maintenance and upgrades. Expect surprising costs. If you don't have additional money on hand, you may need a bigger home loan that comes with additional funding for solving up.