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How Lenders View Installment vs. Revolving Debt


Written by
Thursday, May 21, 2020

When applying for a mortgage to start the process of an approval, one of the most important things the lender will look at is whether or not you can afford the monthly payments should the loan request be approved. That certainly makes sense but prior to the Consumer Financial Protection Bureau, or CFPB, requiring lenders to determine affordability, some loan programs disregarded income altogether. Affordability wasn’t an issue because income wasn’t verified. That of course all changed when the CFPB implemented the Ability to Repay rule. This ATR required lenders to calculate monthly debt and compare it to gross monthly income to arrive at proper debt ratios.

The mortgage payment used for this calculation includes not just the principal and interest payment to the lender but also a monthly amount for property taxes, homeowner’s insurance and mortgage insurance when needed. This monthly total is compared to gross monthly income to arrive at the “front” or “housing” ratio. In addition, other monthly credit obligations are added to that amount to arrive at the “back” or “total” ratio. Yet some types of credit payments are viewed differently.

Payments such as credit card debt, student loans and car loans and others either fall into the installment category or revolving. When calculating the back ratio, both can be treated differently. Installment debt is like an auto loan. Installment debt means monthly payments are fixed over a predetermined period of time. For instance, an auto loan might be $500 over 60 months. That’s easy enough to figure when calculating debt ratios. Further, when there are less than 10 months remaining, lenders ignore the payment knowing it will soon vanish.

Revolving debt can be a credit card or a line of credit. Revolving debt considers the interest rate on the loan and the outstanding balance. If there’s a credit card payment listed on a credit report, there will be a minimum payment amount. Borrowers can pay that minimum payment, a little more or pay off the balance altogether. The minimum monthly payment will vary based upon the current loan balance when the credit report was pulled. The monthly payments will then rise and fall over time. Lenders will use the minimum monthly payment that appears on a credit report.

Are these debt ratios firm? For most mortgage programs, they’re essentially guidelines, not hard and fast rules. When a lender runs an application through an automated underwriting system for a selected loan, ratios are reviewed as part of the approval process. If a loan program requires debt ratios not exceed 50, an approval won’t be issued. A 50 debt ratio means monthly payments add up to half of the applicant’s gross monthly income. Higher allowable debt ratios are the product of other positive aspects in the loan file such as higher credit scores or a larger down payment.

Finally, we should take a quick look at lease payments. Again, let’s look at a car payment. Instead of an outright purchase, the consumer opts for a lease. When leasing, the borrower doesn’t own the car, but makes regular monthly payments to the lender for a specified period of time. These payments are typically fixed, like an installment loan, but at the end of the lease period the car is returned. An auto lease might be for 48 months, for example. But unlike an installment loan when there are 10 months remaining, lenders still count this debt knowing the borrower will have to either purchase the car outright or return the vehicle and buy or lease another one.



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