Step Three – Debt

The main purpose of step three is to make sure the borrower is not exceeding the maximum amount debt allowed by the program.  In most cases this maximum debt amount is determined by the AUS.

Learning from experience is key for step three.  I don’t complete step 3 all at once when I am reviewing a loan during the underwriting process.  The reason step three is left running through a few more of the steps is most borrowers have multiple source of debts and you have to keep a running total that carries over into a few other steps. Let me describe the common areas borrowers have debt and in what steps you will find the debt and add to the total.

Primary Residence Debt

Found in step 6 if the subject is the primary residence OR step 3 if it is additional property owned (for example if the loan is for a second or investment home the borrowers primary will not be calculated as the subject PITI).  This portion of the debt will include:

  • Rent payment (if the borrower does not own his primary residence)
  • Mortgage payment P&I
  • Property Taxes
  • Home Owners Insurance
  • Mortgage Insurance
  • Home Owners Association Fee

Subject Property Debt

Always found in step 6, this portion will include:

  • Mortgage payment P&I
  • Property Taxes
  • Home Owners Insurance
  • Mortgage Insurance
  • Home Owners Association Fee

Real Estate Owned (REO) Debt

Found in step 3, step 4 while reviewing tax returns you may see the borrower owns properties noted on SCH E, and possibly step 7 in a divorce decree this debt is from other properties the borrowers own that are NOT either the subject property or the borrowers primary residence.  This portion of the debt is calculated by adding up the full PITI for any secondary homes the borrower owns and the net rental income or loss of any investment property the borrower owns.

Installment & Revolving Debt

Found in step 3 on the credit report, possibly step 4 while reviewing the borrowers income documents, possibly step 6 while reviewing the borrowers bank statements, or step 7 while reviewing a borrowers divorcee decree.  This portion of the debt will include:

  • Any installment loans noted on the credit report (IE car loan or student loan)
  • Revolving credit debt (visa, MasterCard, AMEX)
  • Lease payments
  • Child support or alimony payments
  • Co-signed debts

Again, these debts will not all be calculated all at once and you will have to keep a running total of the different types of debts.  Besides the basic function of finding and adding up all the debts here are some additional items you will most likely need to complete during step 3.

  • Reviewing to insure all debts reporting on the credit report are reflected on your L.O.S. or 1003
  • Insure that the debt type, is accurately reflected in your L.O.S. or 1003 ( I.E. a car lease vs payment)
  • Insure that you are properly reporting debt paid off so that it is not included in the debt ratio

For some borrowers a big part of completing this step is when a borrower has additional properties such as vacation homes and rental properties.  These large ticket items can push a person’s debt ratios well out of line very quickly!  There is no easy way to explain additional properties so for this guide and keeping it simple my advice here is to use this step to make sure you have the accurate payment information about each additional property owned.  Evaluating rental income (or loss) falls into step 4 but if you don’t have the accurate property payment you will not get the rental income or loss part right!