California Real Estate Broker ExaminationFinancingMedium
A lender is evaluating a loan application and calculates a borrower's housing expense-to-income ratio at 30% and their total debt-to-income ratio at 42%. The lender's standard qualifying ratios are 28/36. Based on these ratios, what is the most likely outcome for this loan application?
- AThe loan will be approved if the borrower has excellent credit.
- BThe loan will be denied because the total debt-to-income ratio exceeds limits.
- CThe loan will be denied because both ratios exceed the limits.
- DThe loan will be approved due to sufficient income.
Show answer & explanationAnswer & explanation
Correct answer: B. The loan will be denied because the total debt-to-income ratio exceeds limits.
Lenders use debt-to-income (DTI) ratios to assess a borrower's ability to repay a loan. The housing expense ratio (front-end) is 30% (above 28%) and the total debt ratio (back-end) is 42% (above 36%). While the housing ratio is also higher, the total DTI is usually the more critical 'back-end' ratio. Exceeding the back-end ratio (42% vs. 36%) makes denial very likely, even if the front-end ratio was acceptable.
Why the other options are wrong
- A. While excellent credit can sometimes offset minor ratio issues, exceeding both standard ratios significantly makes approval unlikely without other compensating factors not mentioned.
- C. While both ratios exceed the limits, the total DTI is often the more stringent and controlling factor for denial, making C a more precise reason based on typical lending practices.
- D. Both ratios exceed the standard limits, indicating insufficient income relative to debt.
Debt-to-Income Ratio (DTI)
A financial measure that compares a borrower's monthly debt payments to their gross monthly income, used by lenders to assess repayment ability.
- Two ratios: housing expense (front-end) and total debt (back-end).
- Common limits are 28% for housing and 36% for total debt.
- Calculated as (Monthly Debt Payments / Gross Monthly Income) * 100.
Memory trick: DTI: Don't Take Too much.