Debt to Income Ratio Requirements for Loan Modification

Loan modification is a process that a lender and a borrower can enter into together that will change the actual terms of a loan so that the borrower is able to make the monthly payments. Modifying a loan is different from refinancing a loan because the actual terms of the existing loan are just re-negotiated instead of having an entirely new loan written. Banks will look at several different aspects of an individual’s finances before deciding whether a modification can take place.

There are three criteria that can qualify a household for a modification on an existing loan. The first is a personal hardship which has caused a person to become unable to make the monthly payments. The second is a quantifiable financial problem that has not yet affected the ability to make payments, but that will shortly make it impossible. Finally, banks can look at the debt to income ratio of a household to see whether changing a loan will benefit the borrower.

The debt to income ratio is the amount of debt that a person owes in relation to the amount of income over a given period. Banks that are determining whether to perform a mortgage modification will generally look at the front-end debt to income ratio. This is a number that is calculated using the borrowers income and only the remaining amount of the mortgage that is owed. It does not include other expenses.

The back-end debt to income ratio is calculated using all of the debts that a person owes including utility payments and money spent on food. For a household that is in financial trouble, this could be a negative number because the amount of debt each month exceeds the amount of income. Back-end figures are used to assess risk and are also used to determine how much extra income a person will have under the new terms of the loan.

The debt to income ratio requirement for a loan modification varies greatly from one bank to another. The required front-end ratio can be very lenient and in the 50 percent or higher range. More commonly, however, lenders are looking for lower debt ratios. A household with a very high debt ratio might have difficulty acquiring any help without a loan modification lawyer. This is because banks sometimes look at a high debt ratio as being an indicator that an individual will eventually be unable to make monthly payments on time.

There are several government programs such as the Affordable Modification Program (AMP) that actually set guidelines that banks must follow if they choose to participate in the program. These guidelines usually require a front-end debt to income ratio under 30 percent and a back-end ratio under 55 percent after the new terms have been applied. The banks are also required to extend the loan over a 10 year period. The knowledge of a loan modification lawyer can help a household to navigate the sometimes confusing legal and financial areas involved in acquiring a loan modification.