Capacity
The perceived ability for a borrower to repay a loan is influenced by many factors including:
 | income |
| current housing (mortgage or rent) payments |
| debt |
| employment |
| supporting documentation |
While this seems simple enough, it is complicated by:
- The capacity is determined by someone else, not the borrower. In other words, you may have calculated your new mortgage payment and determined that you can afford the payments and you are willing to make those payments. This carries ZERO weight. Your capacity will be determined by someone else, not you.
- Notice the use of the word 'perceived' at the top of this page. The automated systems, loan program guidelines, assessment engines, and underwriters that participate in determining your capacity rely on information that may not be totally accurate or may be misinterpreted. For example, information regarding your debt will be partially determined by a credit report which may contain errors. Perhaps you rely on rental income or over-time pay for qualifying but you are not aware of the limitations on these types of incomes.
Setting those concerns aside for now, let's look at the most common method of viewing one's capacity; the Housing Ratio and the Debt Ratio.
The Housing Ratio is a figure which expresses what percentage of your current monthly gross income will be used to pay the mortgage (principle and interest), hazard insurance, and property taxes (plus Homeowner Association or Condo Fees where appropriate). This figure is determined by dividing your expected Housing Payments (go to calculator) by your gross monthly income. Express the result as a percentage (multiply it by 100 and add the % symbol). Conforming loans typically support Housing Ratios around 28%-33%.
The Debt Ratio is a figure which expresses what percentage of your current monthly gross income will be used to pay your expected Housing costs AND all of your other long-term monthly debt. Your long-term monthly debt is derived from the information on your application combined with that found in a credit report. The Debt Ratio is derived by dividing your monthly debt by your gross monthly income. Again, express the result as a percentage (multiply it by 100 and add the % symbol). Conforming loans typically support Debt Ratios around 36%-38%.
These ratios, while very important, they are also just guidelines in the sense that higher numbers may still be acceptable if there are mitigating factors (e.g., large reserves).