When mortgage companies are evaluating a loan they use debt to income ratios to help determine the ability of the borrower to repay the loan. They do not want to see a borrower overextend themselves and not be able to make the payments. This ratio varies between mortgage companies and loan programs, however it usually is in the neighborhood of 30%-40% (of the borrowerĄ¯s gross monthly income) for front or rear ratios, and may be as high as 50% on the rear ratio. Front ratio means mortgage payment only, and rear ratio is mortgage payment plus other major expenses (car, credit cards, etc.)
So if a borrower earned a gross income of $1000 a month, a 30% front ratio would allow the borrower to qualify for a $300 monthly mortgage payment, and a rear ratio of 50% would mean that total major expenses (including mortgage payment) could not exceed $500 a month.
This practice is designed to help reduce the risk of foreclosure (obviously a headache for the mortgage holder). This practice can be implemented by the seller offering owner financing, and also by the landlord collecting rents, to help reduce the odds of foreclosure or evictions due to non-payment. If the same theory is used when evaluating a prospective buyer, or a prospective tenant, the risk of overextending on the part of the tenant or buyer can be greatly reduced. If you chose to use qualifying ratios of 35% front and 50% rear and the rent for your property is $700 a month, the prospective tenant, or buyer, should have a gross monthly income of $2000 with other major expenses not exceeding $300 a month.
DoesnĄ¯t it make more sense to know that the person owing you money each month can mathematically afford to pay you, on time?
These practices are used by lenders that are in the business of extending loans and collecting payments because they reduce the risk of non-payment, and reduce headaches? As investors, we too are in the business of collecting payments, so we should utilize the proven methods of reducing late payments and saving headaches.
Rob Beeman started investing in real estate in 1996, and enjoys passing on to other investors: Knowledge, Information and Contacts in the forms of Books, Special Reports, Guides and Newsletters, to help them start, accelerate, or supercharge their business.
Source: RealEstateInvestingNetwork.com
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