What Is Debt Service Coverage?

Debt service coverage refers to when a bank is securing their risk on a loan by requiring a minimum down payment or mortgage insurance in case of a loss. The borrower’s debt to income ratio will be calculated, along with the loan to value of the home. Many banks will require you to secure mortgage insurance if you offer anything less than a 20% down payment on the home. Ransom Kelly at Assurance Financial is here to explain debt service coverage. We hope you contact us for more information after reading this week’s blog for Birmingham Alabama customers.

Mortgage Insurance

If you are required to get mortgage insurance, this cost will usually be added up-front and rolled into your monthly mortgage payments. Mortgage insurance rates can vary from 0.5% to 1.5% of the original loan value. For example, a loan of $200,000 may have a monthly fee of around $160. This insurance is not the same thing as homeowners insurance. It offers protection for the lender in the case of a loss on their loan. It does not cover a homeowner for any damages or issues in the home that was purchase.

Your Debt-to-Income Ratio

Banks will review your debts carefully in the process of approving your loan. This helps them understand and weigh their risks. This process is helps the bank determine its debt service coverage requirements. This amount can be found by subtracting your monthly debts (auto loans, credit balances, student loans, etc.) from your total income prior to tax. Your anticipated mortgage payments can be included in this calculation. Other factors to consider include how high the interest rates are for the debts, your credit score, and when debts will be paid.

Having a High Debt-to-Income Ratio

Many banks prefer to see a debt-to-income ratio of less than 43%. The lender will review the up front and back end costs of owning a home and its relationship to your debt. If you have a high debt-to-income ratio, than this may increase the costs of your mortgage. You may be offered a higher interest rate or requirements for mortgage insurance. All of this helps a bank determine its debt service coverage. The process of assessing your risk in taking out a mortgage is there to help both you and your lender. Whether or not you are asked to make a minimum down payment or to purchase mortgage insurance, we are here to help.

Ransom Kelly at Assurance Financial enjoys helping homebuyers understand the complex market of mortgage insurance and debt service coverage. Visit our website to learn more, play with investment tools, or speak to our staff directly by calling our Birmingham, Alabama office.