One of the mysteries of home loan modifications is how each lender treats the debt ratios of the homeowner. While lenders do not make the information public, law firms in the course of executing hundreds modifications with lenders have become familiar with acceptable ranges at each one. The knowledge of what lenders are looking for in terms of these ratios prior to starting the process can make the difference between the relief of getting a home loan modification and  the fear of facing foreclosure.  

There are actually two debt ratios that figure in to the loan modification process. The first is the ratio of the mortgage payment which includes taxes, insurance, and HOA dues, if applicable, to the homeowner’s gross monthly income. Under the guidelines of the Obama administration’s Making Home Affordable, the ending target for the ratio is 31%. The standard of each lender, in terms of this ratio, will vary but will generally be close to that of the government program.

The second ratio, which often determines whether a loan modification is approved or not, is overall expenses, including the mortgage payment, as a ratio to gross income. Lenders look very closely at this ratio to determine whether the homeowner will be at risk of slipping back into default even after the modification lowers the monthly payment. In fact, homeowners can be well under the guideline standard for the income to housing debt ratio but end up with a non-approval due to a high number for the income to total debt ratio. It should also be noted that a homeowner can get a non-approval for a loan modification if either ratio is too low due to the hardship requirement imposed by both the government and private lenders.      

If the total monthly debt payments of a homeowner include obligations toward unsecured debt, a debt settlement can play a significant role in bringing the ratio to a level that fits within a lender’s parameters. For the total debt to income ratio, acceptable ranges can vary widely but generally fall within 38 to 45%. The administration‘s guideline allows for this ratio to go as high as 52% but in any loan modification the lender always has the final say.

While a debt settlement has a variety of benefits, the reduction of the monthly payments associated with all debts rolled in to the settlement can have a material effect on the success or failure of the loan modification process. Because the typical reduction in payments is approximately 50%, a homeowner that that may be carrying too much in the way of debt payments can bring that ratio back in line immediately by initiating a debt settlement.

Here’s how it would work:

* Homeowner’s gross income is $7,500 per month.

* Mortgage payment is $2,450 for a housing to income ratio of 32.6%.

* The homeowner is carrying about $50,000 in unsecured debt. The minimum monthly payment on all accounts is $1,450 leaving the total monthly payment on all debt at $3,900.

* The ratio of total debt to income is 52%, much too high to get approval for a loan modification.

* By initiating a debt settlement, the homeowner immediately cuts the payment on unsecured debt down to $725 per month.

* The new ratio on total debt to income drops to 42.3%, within the acceptable range of approval for the lender.

In this example, the homeowner would receive receive further relief with the approval of the loan modification which, combined with the debt settlement, would reduce payments by well over $1,000 per month. An experienced attorney can synchronize the debt settlement and the loan modification to provide other benefits as well including timing the payoff of settled accounts to provide additional cash flow and the re-building of credit scores.