The mortgage modification process requires many of the same steps involved in getting a new mortgage, among them, a debt-to-income comparison. Before restructuring a loan for a struggling homeowner, the lender evaluates a borrower's capacity to repay based on revised terms that lower the payments. Lenders set guidelines for the debt-to-income ratio, or DTI. On a modification, the lender may exercise flexibility with regards to DTI rules, based on the modification type and borrower circumstances.
Front- to Back-End DTI
Lenders consider two types of DTI when qualifying you for a mortgage, known as front-end and back-end DTI ratios. The front-end ratio compares your housing payment, which includes mortgage principal, interest, property taxes and homeowners insurance to your gross monthly income. Your total housing payment is known as the "PITI," named after its main components. The back-end DTI compares your housing payment plus other monthly recurring debts, such as credit card and loan payments, to your gross income. In a modification, the lender sets benchmark DTI front-end ratios.
Lender Target Payments
Your front-end DTI before modifying must exceed a certain percentage to qualify for a modification. The modification's intent is to bring the DTI down to the lender's benchmark, or within a reasonable DTI range. A typical benchmark DTI ratio among mortgage lenders is 31 percent, therefore, lenders modify loans in which they can reach a target payment around 31 percent of your income. They may lower the interest rate, forgive a portion of the loan balance, extend the loan's repayment term or use a combination of these strategies to reach the target payment.
Program DTI Rules
Lenders and mortgage investors treat DTIs differently when considering a loan modification. For example, the federal government sponsors the Home Affordable Modification Program, or HAMP, which incentivizes lenders to approve modifications under streamlined guidelines. HAMP has a front-end DTI of 31 percent; however, it requires borrowers with debt that pushes back-end DTIs to 55 percent or higher to undergo credit counseling. At the time of publication, Fannie Mae and Freddie Mac developed the "Streamlined Modification Initiative," which required no income or financial hardship documentation. Rather than rely on DTI, lenders reduce the interest rate based on average 30-year mortgage rates, extend repayment to 40 years and may waive interest on a portion of the unpaid mortgage balance.
When calculating the DTI, your PITI may exceed basic principal, interest, tax and insurance costs, making it more difficult to bring your payment down to the lender's required target. For example, if you obtained the loan with minimal or no down payment, your PITI also might include mortgage insurance, which covers the lender if you default. Lenders also include homeowners association dues, HOA special assessments and local taxes in the PITI if required for your area.
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