by Mary Norman

Created on: August 23, 2008

While there is not a single formula to follow, lenders have specific guidelines for granting loans. It is a complicated evaluation of the property/collateral used as security for the loan as well as the borrower's ability and willingness to repay the loan.

Borrower's Ability to Repay

The lender must determine how much income an applicant is able to devote to the loan payment. Possible sources of income include base salary, overtime, part-time and second job income, bonuses and commission, retirement, dividend/interest income, rental/investment income, alimony or child support and welfare. Once a lender determines an applicant's gross monthly income, qualifying ratios are calculated. These ratio's are used to determine how much income is available to repay the loan each month.

If the loan requested is for the purchase of real estate, a housing ratio is used to analyze a prospective borrower's ability to pay for the home. Expenses in the ratio include the mortgage payment, real estate taxes, property insurance, homeowners or condominium association dues and mortgage insurance.

A debt-to-income ratio is calculated based on information specified in the application and credit reports. This ratio is used to predict an applicant's ability to adequately meet monthly housing and living expenses in addition to the requested loan amount. Total obligations include the monthly housing expenses plus any debts or loans with remaining terms more than 6 or 10 months.

Any residual income as well as an applicant's liquid assets are also used when determining the borrower's ability to repay a loan. Residual income is the gross income less taxes, social security, defined deductions and shelter expense. It is basically the money left to the applicant after all monthly expenses are paid. Liquid assets represent the funds the applicant has available for unexpected expenses. Both residual income and the amount of liquid assets are used to determine the applicant's ability to pay in the event there is a sudden loss of income.

The accumulation of substantial liquid assets is a strong indicator of financial responsibility. This provides a positive factor in analyzing both the ability and willingness to repay the loan. It is quite possible that a prospective borrower can qualify for a monthly mortgage payment, but lacks the cash to close; or the applicant may be able to pay for closing, but will be wiped out financially to do so. Without any cash reserves, the applicant may not be able to make

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