LIABILITIES & DEBT RATIO, CONVENTIONAL

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1 Overview / General... 3 Related Bulletins... 3 Overview... 3 Underwriting Methods... 3 Evaluating Ability to Pay... 4 Monthly Housing Expenses... 3 Qualifying Housing Payment... 4 Total Qualifying Debt-to-Income Ratios... 4 Higher Monthly Payment Ratio... 6 Monthly Debt Obligations... 6 Alimony, Child Support and Maintenance Payments... 6 Authorized User... 6 Bridge Loans... 7 Business Debt in Borrower's Name... 7 Co-Signed Loans... 7 Court-Ordered Assignment of Debt... 8 Deferred Installment Debt... 8 Home Equity Lines of Credit... 8 Installment Debt... 9 Lease Payments... 9 Loans Secured by Financial Assets... 9 Mortgage Assumptions... 9 Open 30-day Charge Accounts Other Real Estate Owned Property Settlement Buy-Out Revolving Charge/Lines of Credit Undisclosed Liabilities Voluntary Recurring Debts Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 1 of 13 Revised 1/3/2013

2 Debt Pay Off/Pay Down Variable Payment Mortgages and Buydowns Qualifying the Borrower and Payment Shock Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 2 of 13 Revised 1/3/2013

3 Overview / General The Liabilities & Debt Ratios standards apply to all Plaza Home Mortgage, Inc., Conventional Loan Programs. Generally, requirements that vary from one Loan Program to another are described in our Program Summaries and, in most cases, those program-specific differences will not be referenced in this section. Regardless of underwriting requirements, additional information may be requested at the discretion of the underwriter. Related Bulletins Overview None at this time. Ratios are used to compare the borrower s anticipated monthly housing expense and total monthly obligations to stable monthly gross income. These ratios indicate limitations on the borrower s ability to meet expenses involved in home ownership. Loan ratio requirements are discussed under the following topics: Monthly Housing Expenses Qualifying Housing Payment Monthly Debt Obligations Total Qualifying Debt-to-Income Ratios (DTI) Possible Exclusions to DTI Debt Payoff Underwriting Methods Guidelines contained in this chapter are applicable to loans underwritten by Desktop Underwriter and Loan Prospector, unless otherwise stated. Loans may be underwritten by any one of the following methods: Automated Underwriting: Loans underwritten by Desktop Underwriter or Loan Prospector o Loans underwritten by Desktop Underwriter and Loan Prospector may follow the DU Underwriting Findings Report or Loan Prospector Feedback Certificate unless otherwise stated in Plaza s Program Summaries. Evaluating Ability to Pay Monthly Housing Expenses The borrower s ability to pay the monthly housing expense, in addition to other monthly obligations, must be carefully evaluated. Higher housing expense ratios may be acceptable with compensating factors such as a consistently low consumer level of debt, proven ability to manage that level of housing expense, or substantial equity in the subject property. Monthly housing expenses are required to calculate the anticipated total monthly housing expense-to-income ratio. Housing expense-to-income ratios compare monthly housing expenses to stable gross monthly income. Monthly housing expenses include the following: Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 3 of 13 Revised 1/3/2013

4 Principal and Interest payments on the first mortgage loan Interest payments for Interest Only loans Subordinate financing payments on mortgages secured by the subject property Hazard insurance premiums Flood insurance premiums Mortgage insurance premiums Real estate taxes Homeowners' association dues Leasehold payments Ground rent Special assessments Qualifying Housing Payment Total Qualifying Debt-to- Income Ratios Generally, the principal and interest payment, based on the actual interest rate is used to determine the borrower's monthly housing expense. See Plaza s Program Summaries for specific requirements on qualifying rates, formulas and limitations. Debt-to-income ratios compare all monthly obligations and debt payments to monthly stable income. In evaluating the total debt-to-income ratio, be aware of the degree and frequency of credit usage and its impact on borrower's ability to repay the loan. The debt-to-income ratio is a factor in determining the Loan Program for which borrower is eligible. The maximum allowable debt-to-income ratio will vary by individual Loan Programs. Loans with non-occupant co-borrowers: The owner-occupant must qualify at 35%/43% maximum ratios, regardless of the LTV. Blended Ratio s Allowed with LP Accept Findings. Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 4 of 13 Revised 1/3/2013

5 Higher Monthly Payment Ratio It may be appropriate in some cases for the borrowers to have higher monthly payment ratios. Examples of these situations are: The borrower s demonstrated ability to maintain a good credit history, accumulate savings, and control consumer debt obligations A large down payment The borrower s probability for increased earnings based on education, job training, or time employed. The borrower s demonstrated ability to carry a higher housing expense or higher debt level while maintaining a good credit history. If any of the above, or any other situation, is considered to justify higher ratios, a written explanation supporting the decision must be included in the loan file. An energy efficient property that reduces energy costs. The borrower s ability to repay mortgage debt is critical in evaluating the overall quality of the loan. Assess the borrower s liabilities relating to the number of active accounts, usage and repayment history. Evaluation of the borrower s capacity includes an assessment of the borrower s financial obligations in relation to income. The total monthly debt obligations considered is the sum of all housing expenses plus any other monthly expenses incurred by the borrower. Any additional debt obtained as a result of a recent inquiry on the credit report must be included in the monthly debt obligation. See the Debt Pay Off/Pay Down section in this guideline regarding paying off or paying down debt to qualify. Monthly Debt Obligations Monthly Debt Obligation Monthly expenses include: Alimony, Child Support, and Maintenance Payments Authorized User Bridge Loans Business Debt in Borrower's Name Co-Signed Loans Court-ordered Assignment of Debt Deferred Installment Debt Home Equity Lines of Credit Installment Debt Lease Payments Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 5 of 13 Revised 1/3/2013

6 Loans Secured by Financial Assets Mortgage Assumptions Open 30-day Charge Accounts Other Real Estate Owned Property Settlement Buy-out Revolving Charges/Lines of Credit Undisclosed Liabilities Voluntary Recurring Debt See the Transactions Guideline for qualification if current primary residence is pending sale, or is a conversion to a second home or investment property. Alimony, Child Support and Maintenance Payments When the borrower is required to pay alimony, child support, or maintenance payments under a divorce decree, separation agreement, or any other written legal agreement, and those payments will continue for more than ten months, the payments must be considered in the debt-to-income ratio (and may not be deducted from income). The alimony, child support and maintenance payments may not be deducted from income. Voluntary payments do not need to be taken into consideration. One of the following is required to document the payment and the number of remaining payments: o A copy of a written legal agreement or court decree describing the payment terms for the obligation, the amount of the award, and the period of time over which it will be received. o Any applicable state law that mandates the obligation document, which must specify the conditions under which payments must be made Authorized User An authorized user account is when a credit account owner permits another person, typically a family member who is managing credit for the first time, to have access to and use an account, the user is referred to as an authorized user of the account. Credit report tradelines that list a borrower as an authorized user can no longer be considered in the underwriting decision, except in the following instances: o Another borrower in the mortgage transaction is the owner of the tradeline; or o The borrower can provide written documentation (e.g. canceled checks, payment receipts, etc.) that he or she has been the actual and sole payer of the monthly payment on the account for at least 12 months preceding the date of the application. If an applicant is an authorized user of any credit report tradeline that belongs to the applicant s spouse, and that spouse is not a borrower in the mortgage transaction, the lender must consider such authorized user tradelines in the underwriting decision. Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 6 of 13 Revised 1/3/2013

7 If there is written documentation of the borrower s monthly payments on the authorized user account, then the payment history (particularly any late payments that are indicated) must be considered in the credit analysis and the monthly payment obligation must be included in the debt-to-income ratio. Bridge Loans A bridge loan is a form of mortgage secured by the borrower's present home, which is for sale. By using funds from this loan, the borrower can close on a new home before selling the present home. Bridge loans must be included in the borrower's debt-to-income ratio. See the Transactions and Asset Guidelines for more information. Business Debt in Borrower's Name When a self-employed borrower indicates that certain liabilities are paid by his or her business, it must be confirmed that the obligation was paid from company funds and meets all of the following requirements: o There is no history of delinquency. o A minimum of twelve months evidence documenting that the debt is paid by the business account. o The cash flow analysis of the business took the payment obligation into consideration. The payment must be included in the borrower s individual recurring monthly debt obligations if any of the following situations exist: o The business does not provide sufficient evidence that the obligation was paid out of company funds. The business provides acceptable evidence of its payment of the obligation, but the cash flow analysis of the business does not reflect any business expense related to the obligation (such as an interest expense - and taxes and insurance, if applicable - equal to or greater than the amount of interest that one would reasonably expect to see given the amount of financing shown on the credit report and the age of the loan). It is reasonable to assume that the obligation has not been accounted for in the cash flow analysis. o If the account in question has a history of delinquency. o To ensure that the obligation is counted only once, adjust the net income of the business by the amount of interest, taxes, or insurance expense, if any, that relates to the account in question. Co-Signed Loans When a borrower co-signs for a loan to enable another party (the primary obligor) to obtain credit, but is not actually repaying the debt, the borrower has a contingent liability. The contingent liability must be included in the debt-to-income ratio, unless there Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 7 of 13 Revised 1/3/2013

8 is documentation to evidence the primary debtor has been making satisfactory payments for a minimum of 12 consecutive months and the account is current Evidence such as cancelled checks or automated savings withdrawals will be accepted. Court-Ordered Assignment of Debt When the borrower has an outstanding debt that was assigned to another party by a court order (e.g., divorce decree or separation agreement), and the creditor does not release the borrower from liability, it may be excluded from the debt-toincome ratio if all of the following can be documented: o Copy of the court order assigning the debt o Proof of transfer of ownership The payment history of the debt need not be taken into consideration after the transfer date occurred, after the assignment to another party. Deferred Installment Debt Loans deferred or in forbearance are always included in the loan qualification. If the credit report does not indicate the monthly amount that will be payable at the end of the deferment period, copies of the borrower s payment letters or forbearance must be obtained to determine the monthly payment used for loan qualification. For deferred student loans only, if the credit report does not indicate the monthly amount that will be payable at the end of the deferment period, 2 percent of the original principal balance of the student loan may be used to determine the monthly payment used for loan qualification. Home Equity Lines of Credit When the subject property has a home equity line of credit that has a balance and monthly payment, that payment must be considered part of the borrower's recurring monthly debt obligations. If not shown on the credit report, payments on a home equity line of credit with an outstanding balance may be calculated at 1% of the outstanding balance or the payment reflected on the Borrower s billing statement. If the HELOC does not require a payment and there is no recurring monthly debt obligation, no monthly payment needs be included in the recurring debt obligations. If there are other open home equity lines of credit on the credit report with a zero balance, no monthly payment needs to be included in the recurring debt obligations. All conventional loans with subordinating HELOCs are qualified and priced at the full line amount regardless of the draw amount. The CLTV and HCLTV are Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 8 of 13 Revised 1/3/2013

9 considered the same in these situations. Installment Debt Installment debt that is not secured by a financial asset, including student loans, automobile loans, timeshares, and home equity loans, must be included in the borrower's monthly debt obligations, if there are more than ten months remaining. On a case-by-case basis, an installment debt with fewer than ten monthly payments remaining should be considered as a recurring monthly debt obligation if it significantly affects the borrower's ability to meet his or her monthly obligations. Lease payments are not considered Installment Debt, Refer to the Lease Payment section below for requirements. For loans underwritten by Desktop Underwriter, Desktop Underwriter determines whether to include installment debts with fewer than ten monthly payments remaining. Lease Payments Lease payments must be included in the borrower's recurring monthly debt obligations, regardless of the number of months remaining on the lease. Loans Secured by Financial Assets The borrower may use his or her financial assets (life insurance policies, 401k accounts, individual retirement accounts, certificates of deposit, stocks, bonds, etc.) as security for a loan. The payment on this type of loan is not required to be included in the debt-to-income ratio, provided the applicable loan instrument shows the borrower's financial asset as collateral for the loan. If the borrower intends to use the same asset to satisfy reserve requirements, reduce the value of the asset by the proceeds from the secured loan and any related fees to determine whether the borrower has sufficient reserves. Mortgage Assumptions When the borrower sells a property and the property purchaser assumes the outstanding mortgage debt without a release of liability, the borrower has a contingent liability. The contingent liability (PITIA) does not need to be included in the debt-toincome ratio if verification that the property purchaser has at least a 12-month history of making regular and timely payments for the mortgage is provided. The following documentation must be provided: o Evidence of transfer of ownership. o Copy of the formal, executed assumption agreement. o Credit report indicating that consistent and timely payments were made for the assumed mortgage. Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 9 of 13 Revised 1/3/2013

10 If timely payments for the most recent 12-month period cannot be documented, the mortgage payment must be included in the borrower's recurring monthly debt obligations. Open 30-day Charge Accounts Open 30-day charge accounts with account balances are required to be paid off unless one of the following is satisfied: o Borrower has sufficient assets to cover the unpaid balance. o Borrower will receive reimbursement of the charges from his or her employer. Other Real Estate Owned Mortgage payments and related expenses on any non-income producing real estate must be included in the borrower's recurring debt obligations. This includes mortgage payments and related expenses on any property which is currently pending sale (not closing prior to subject transaction), or a property retained as a second home or investment property. o Aggregate net negative rental income from all rental properties. Use Plaza s Income Worksheet to calculate. o Current rental payment (when borrower is currently renting and purchasing a second home or investment). For details regarding the qualifying impact of other real estate owned, see Plaza s Transactions Guideline. When the loan application reflects the borrower owns other real estate free and clear of mortgage liens or encumbrances, evidence is typically not required. However, under certain circumstances the underwriter may require documentation confirming the real estate is unencumbered. The borrower must qualify with the applicable taxes, hazard insurance, homeowners' association dues/fees (if applicable), and any other related expenses, which must be documented. Property Settlement Buy-Out When the borrower s interest in a property is bought-out by another co-owner of the property, the mortgage lender may not release the borrower from liability under the mortgage, thus creating a contingent liability for the borrower. This contingent liability does not need to be included in the debt-to-income ratio provided there is documentation to evidence the transfer of title of the property. If timely payments for the most recent 12-month period cannot be documented, the mortgage payment must be included in the borrower's recurring monthly debt obligations. Revolving Charge/Lines of Credit Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 10 of 13 Revised 1/3/2013

11 Revolving charge accounts and unsecured lines of credit are open-ended and should be treated as long-term debts and must be considered part of the borrower's recurring monthly debt obligations. These trade lines include credit cards, department store charge cards, and personal lines of credit. If the credit report does not show a required minimum payment amount and there is no supplemental documentation to support a payment of less than 5 percent, use 5 percent of the outstanding balance as the recurring monthly debt obligation. For Desktop Underwriter, if a revolving debt is provided on the loan application without a monthly payment amount, Desktop Underwriter will use the greater of $10 or 5 percent of the outstanding balance as the monthly payment when calculating the total debt-to-income ratio. Undisclosed Liabilities Borrowers who do not disclose any or all debts on the initial residential loan application can raise concerns. All debts of the borrower incurred or closed up to and concurrent with the closing of the subject mortgage must be disclosed on the final loan application and included in the qualification for the subject loan. If additional liabilities are discovered up to and concurrent with the loan closing each additional debt must be documented as follows: o Verify the unpaid balance. o Verify the terms of repayment. o Verify the borrowers pay history (if applicable) by obtaining documentation from the borrower or creditor. If there is a new subordinate lien on the subject property the loan must be re underwritten. The DTI must be recalculated based on the additional debt, and must be reunderwritten through the AUS system if the following apply: o The recalculated DTI exceeds 45%: The recalculated DTI does not exceed 45%, but increased by 3% or more from the original AUS approval. Voluntary Recurring Debts Voluntary recurring debts should generally not be considered in the underwriting analysis or subtracted from gross income (401k contributions, 401k loans, union dues, commuting expenses, open accounts with zero balances, federal, state, and local taxes, or other voluntary deductions). Specific circumstances in an individual file must always be analyzed. See the Employment and Income Analysis and Documentation Guideline for treatment of business expenses. Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 11 of 13 Revised 1/3/2013

12 Debt Pay Off/Pay Down Pay off or pay down of debt solely to qualify must be carefully evaluated and considered in the overall loan analysis. The borrower s history of credit use should be a factor in determining whether the appropriate approach is to include or exclude debt for qualification. Add examples such as high credit users and why we may need to still factor in payments even if we are paying the account(s) off at closing. Pay Off of Revolving Debt for Loan Qualification: o Desktop Underwriter, Loan Prospector, Permitted if the revolving account is paid off and closed. If the revolving account is not closed, the debt must be included in the debt-to-income ratio. Pay Off of Installment Debt for Loan Qualification: o Desktop Underwriter, Loan Prospector, Permitted. Pay Down of Revolving Debt for Loan Qualification: o Not permitted. Pay Down of Installment Debt for Loan Qualification: o Desktop Underwriter and Loan Prospector are permitted. If the debts being paid off or paid down, the source of funds must be documented and verified. In addition, documentation must be provided to reflect the revolving account is paid off and closed prior to closing. If an installment debt is paid off at closing, the creditor must provide a pay off statement which same balance must be reflected as the pay off amount on the HUD-1 Settlement Statement. Variable Payment Mortgages and Buy downs Although many of the features of variable payment mortgages and buy downs, such as limits on initial discount rates for ARM products, help to protect the borrowers from payment shock, they cannot totally insulate the borrowers from the risk of payment increases. Therefore, the borrower s capacity to handle increased payments should be carefully evaluated. The following Credit-related issues should be considered when determining Capacity for borrowers with variable payment mortgages or buy downs: Current liquid assets o Generally, borrowers should have at least two months reserves after closing. If the borrowers have substantial liquid assets remaining, the borrowers should be viewed more favorably. When evaluating liquid assets consider income stability and potential for earnings Potential to experience increased earnings o For borrowers to keep pace with increasing payments, the borrowers must have above-average increases in earnings. A review of the borrower s employment history may provide enough information to make this determination. o Little or no increases in earnings over the past two to three years provide little reason to assume there is potential for large future increases. Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 12 of 13 Revised 1/3/2013

13 Qualifying the Borrower and Payment Shock Transactions resulting in significant payment shock should always be considered by the underwriter. If the borrower s mortgage payments will more than double, the underwriter must clearly document how the borrowers will be able to make the higher payments. It is always at the underwriter s discretion to require additional verification of assets or a larger down payment as a compensating factor for a loan with high payment shock. Fixed Rate Loans: Borrower must qualify based on the Note Rate. Interest Only Loans: Borrower must qualify at the PITI payment based on the fully amortized rate. Variable Rates: Refer to the Variable Payment Mortgages and Buy downs section within this document. Liabilities & Debt Ratio, GD-COUG-007 rev. 08 Page 13 of 13 Revised 1/3/2013

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