Mortgage lenders are chiefly concerned with your ability to repay the

mortgage. To determine if you qualify for a loan, they will consider

your credit history, your monthly gross income and how much cash
you'll be able to accumulate for a down payment. So how much house
can you afford? To know that, you need to understand a concept
called "debt-to-income ratios."
Debt-to-income ratios

The standard debt-to-income ratios are the housing expense ratio and the
total debt-to-income ratio. These are also known as the front-end and backend ratios, respectively.
Front-end ratio: The housing expense, or front-end, ratio shows how
much of your gross (pretax) monthly income would go toward the mortgage
payment. As a general guideline, your monthly mortgage payment,
including principal, interest, real estate taxes and homeowners insurance,
should not exceed 28 percent of your gross monthly income. To calculate
your housing expense ratio, multiply your annual salary by 0.28, then divide
by 12 (months). The answer is your maximum housing expense ratio.
Front-end ratio

Maximum housing expense ratio = annual salary x 0.28 / 12 (months)

Back-end ratio: The total debt-to-income, or back-end, ratio, shows how
much of your gross income would go toward all of your debt obligations,
including mortgage, car loans, child support and alimony, credit card bills,
student loans and condominium fees. In general, your total monthly debt
obligation should not exceed 36 percent of your gross income. To calculate
your debt-to-income ratio, multiply your annual salary by 0.36, then divide
by 12 (months). The answer is your maximum allowable debt-to-income
ratio.
Back-end ratio

Maximum allowable debt-to-income ratio = annual salary x 0.36 / 12

(months)
Example

Take a homebuyer who makes $40,000 a year. The maximum amount for
monthly mortgage-related payments at 28 percent of gross income is $933.

($40,000 times 0.28 equals $11,200, and $11,200 divided by 12 months

equals $933.33.)
Furthermore, the lender says the total debt payments each month should
not exceed 36 percent, which comes to $1,200. ($40,000 times 0.36 equals
$14,400, and $14,400 divided by 12 months equals $1,200.)
Following the tech bubble and the economic trauma that followed the terrorist
attacks on the U.S. on September 11, 2001, the Federal Reserve stimulated
the struggling U.S. economy by cutting interest rates to historically low levels.
As a result, the housing market soared for several years. In order to capitalize
on the home-buying frenzy, some lenders extended mortgages to those who
couldnt qualify for traditional loans because of a weak credit history or other
factors. Investment firms were eager to buy these loans and repackage them
as mortgage-backed securities (MBSs).
Many subprime mortgages were adjustable-rate loans that were initially
affordable, but which reset to a dramatically higher interest rate after a given
period of time. This sudden spike in payments played a major role in the
growing number of defaults, starting in 2007 and peaking in 2009. The
ensuing meltdown caused dozens of banks to go bankrupt, and led to
enormous losses from Wall Street firms and hedge funds that marketed or
invested heavily in risky mortgage-related securities. The fallout was a major
contributor to the global recession that followed.
In the wake of the subprime meltdown, myriad sources have received blame.
These include mortgage brokers and investment firms that offered loans to
people traditionally seen as high-risk, as well as credit agencies that proved
overly optimistic about non-traditional loans. Critics also targeted mortgage
giants Fannie Mae and Freddie Mac, which encouraged loose lending
standards by buying or guaranteeing hundreds of billions of risky loans.

DEFINITION OF 'REVERSE MORTGAGE'

A type of mortgage in which a homeowner can borrow money against the
value of his or her home. No repayment of the mortgage (principal or interest)
is required until the borrower dies or the home is sold. After accounting for the
initial mortgage amount, the rate at which interest accrues, the length of the

loan and rate of home price appreciation, the transaction is structured so that
the loan amount will not exceed the value of the home over the life of the loan.
Often, the lender will require that there can be no other liens against the
home. Any existing liens must be paid off with the proceeds of the reverse
mortgage.

INVESTOPEDIA EXPLAINS 'REVERSE MORTGAGE'

A reverse mortgage provides income that people can tap into for their
retirement. The advantage of a reverse mortgage is that the borrower's credit
is not relevant, and is often unchecked, because the borrower does not need
to make any payments. Because the home serves as collateral, it must be sold
in order to repay the mortgage when the borrower dies (in some cases, the
heirs have the option of repaying the mortgage without selling the home).
These types of mortgages have large origination costs relative to other types
of mortgages. These costs become part of the initial loan balance and accrue
interest. Senior citizen borrowers with good credit should carefully analyze the
options of a more traditional mortgage, such as a home equity loan, against a
reverse mortgage.