Posted by Elizabeth Dennis on July 18, 2011 | No Comments
If you are thinking that 2011 might be the year you want to purchase a house, you are probably not alone. And since most people have to have a mortgage to pay for that house, there are some steps you can take now to help make the process a little easier and worry free.
Getting a mortgage can be a time consuming and confusing process. One of the best ways to deal with it is to break down the entire process into several different steps. This will help keep you from getting overwhelmed and also from missing an important phase.
One of the first things you should do when considering buying a house and deciding to get a mortgage is to determine just how much house you can afford. This is typically a function of two things: how much you can borrow from a bank or credit union versus how much money you can afford to put down. It will also depend a great deal on how much money you make. While there is no magic number for the perfect home or getting the perfect mortgage, you typically don’t want to spend more than 25% of your take home pay on a house note every month. In order to determine how much you can spend, take some time to insert your monthly income, expenses, term of loan, down payment and interest rate into an online mortgage calculator.
Next, you will want to determine what type of mortgage you want. If you can, determine if you can afford to take out a fifteen year mortgage rather than a thirty year one. This will not only save you thousands of dollars in interest, but you’ll own the house much sooner.
Before applying for a mortgage, you will also want to shop for one. Many people still choose to go to their local bank and apply for one there. This is especially true when you might get a small discount in interest rates if you already have accounts at that particular bank. However, a more and more popular option is to look for a mortgage broker. These brokers act as a go between for you and lending organizations. They take care of all the paper work and help find you the best deal possible by shopping your mortgage application to numerous different lenders. Do keep in mind, however, that they will charge a percentage of the loan for their services.
Next, get your finances in order and determine how much money you can afford to put down on your new house. While no money down loans are almost a thing of the past, you can still find loans and get mortgages with down payments of as little as 3.5-4%. However, you ideally want to be able to put down 10-20%. This will not only make you more attractive to a lending institution, but will save you money and interest. In addition, you will want to get a copy of your credit report. Those with a FICO score of at least 730 will get the best rate. For FHA loans, you will need a score of at least 690. Finally, try to be debt free and have at least six months of savings in the bank in addition to the money you have earmarked for the down payment.
If you follow the above the tips, you will make the entire mortgage process much easier and increase your chances of being approved with an acceptable interest rate.
Posted by Elizabeth Dennis on January 12, 2010 | No Comments
By now, you’ve heard all about how your credit rating and score will affect your ability to get a mortgage with desirable terms and the lowest possible interest rate. There exists however, another important piece to the puzzle, and that is your current debt load. It is one thing to know that you’ve paid your past debts one time; but can you continue to do so if you take this new mortgage? Calculating what is called your debt-to-income ratio can give you (and your lender) an idea.
What is a Debt-to-Income Ratio?
A debt-to-income ratio represents a percentage of your income that goes toward paying debts. Think of it as a snapshot of your spending habits. Calculating your debt-to-income ratio is very easy. Take a look:
- Monthly Income = $4,000
- Monthly Debt = $1,000
- Divide $1,000 by $4,000 to get .25
- Your debt-to-income ratio = 25%
What is Included in your Income Number
Let us look in a bit more detail, how we calculated the monthly income number in the above example.
Your debt-to-income ratio is best figured on a monthly basis. Your biggest source of income will most likely be your salary. Debt-to-income ratios are based on gross income (that is before taxes and insurance are taken out of your paycheck). To quickly calculate your monthly gross salary, do so with one of two calculations:
- Take your yearly income and divide by 12
- If you get paid biweekly (every other week), take one pay check’s gross pay and multiply it by 2.17
In addition to your monthly paycheck, include:
- Regular income from alimony and child support
- Averages of bonuses, commissions and tips
- Dividends and interest earnings
- Government benefits and assistance
- Income from a side business
- Other miscellaneous income
What is Included in Your Debt Number
Let us take a look at what is included in your monthly debt number:
- Rent or mortgage payment (including property taxes, insurance, private mortgage insurance and association fees)
- Car payment
- Minimum credit card payments (only minimum due; not balances)
- Student loan payment
- Child support and alimony
- Legal judgments
- Other monthly debt obligations
What is Not Included in Your Debt Numbers
- Food bills
- Entertainment expenses
- Utilities
- Clothing
- Informal personal loans
The Results – How to Interpret Your Number
Once you have calculated your debt-to-income ratio, refer to the following to view that snapshot of your spending habits and financial stability:
- 35% or less: a healthy debt load to carry for most people
- 36% – 42%: pay closer attention to your debt before problems arise
- 43% – 49%: take immediate action as financial difficulties may be imminent
- 50% or more: get professional help to aggressively reduce debt
How Mortgage Lenders Use Debt-to-Income Ratios
Mortgage lenders approach the debt-to-income calculation from the other direction. They strive to offer loans that will keep their customers within a specified debt-to-income ratio range. Your lender will use two different ratios to analyze your situation; one factors in only your new housing expense and the other uses your existing recurring debt plus your new housing expense.
The first type of ratio is what is known as a front-end ratio. This is the percentage allowed for housing expenses only. For conventional loans (we’ll see the limits for other loan types later) the front-end ratio limit is 28%.
From our example above:
- Your monthly income is $4,000
- $4,000 times 28% = $1,120
- The maximum loan the lender should offer is one that converts to $1,120 per month in HOUSING ONLY debt.
So far, your lender has calculated a mortgage payment based on your income and housing debt. He will now turn his focus toward your other recurring debt. This can be a game changer. Your lender wants to make sure you can pay for your new loan and still pay for everything else. He will calculate what is called your back-end ratio. The back-end ratio is a percentage allowed for housing expense plus your other recurring debt. In our conventional loan example, a back-end ratio limit is 36%.
- Your monthly income is $4,000
- $4,000 times 36% = $1,440
- The maximum loan the lender should offer is one that converts to $1,440 per month in TOTAL debt.
- If the difference between the back-end and front-end amounts ($1,440 – $1,120) does not cover your other debts, the lender will need to lower the amount he can offer you.
Ratio Limits by Mortgage Type
The front-end and back-end ratio limits differ depending upon the mortgage type. Conventional loans are defined as any loan that is not backed by the federal government.
- Conventional loans: front-end ratio of 28 and back-end ratio of 36
- FHA loans: 31 and 43
- VA loans:: 41 and 41
- Jumbo, non-conforming loans: 45 and 55
The Way the Ratios are Written (and are Mistakenly Read)
In this article I have written the ratios as “28 and 36”. You will see however, the ratio is more commonly expressed as 28/36. This can be misleading. These numbers represent the front-end ratio and a back-end ratio. We are not looking at a fraction or dividing one number into the other. Though because we are talking about ratios, that could be anybody’s first impression.
Other Tips
- Try running your numbers based on net income (after taxes and insurance) to get a better picture of your situation
- Include all of your monthly expenses in your calculation (remember, the lender will only include formal, recurring debt)
- Run your own ratio before you meet with your lender. Read our article about being a responsible home buyer to see why.
Posted by Elizabeth Dennis on January 7, 2010 | 3 Comments
The number one reason for home foreclosures in the United States is a simple one: home owners took out mortgages that they simply could not afford. It is true that in many cases, the lenders did not do much to prevent these doomed-to-fail loans, and in many instances encouraged them. Ultimately however, it is the responsibility of the home buyer to know if they can afford a loan that is offered to them. That said; let us take a look at how critical it is to respect how much you can actually, truly, honestly afford.
How Much You Can Borrow is Different from How Much You Can Afford
A mortgage lender will use a standard calculation to determine how much he is willing to lend you. He will gather from your application, information about your income, debts, credit, and available down payment. By calculating what is called a debt-to-income ratio, your lender will determine how much he can safely (an extremely subjective term) lend you.
However, you must know the following about the lender’s calculation:
- Only recurring debt is included, such as home equity loans, car payments, minimum credit card payments, student loans, furniture store loans, alimony, child support, etc.
- Other miscellaneous debts and obligations such as informal personal loans are not included
- Other household and living expenses are not considered
- Expenses associated with your personal life style are not considered
- Future financial demands and plans with regards to career and family are not considered
- The ratio is based on your gross income, not after-tax income
As you can see, with the many debts and obligations that are excluded in the lender’s calculation, the amount of money he can offer will most likely be higher than you would have thought it to be. This is where the trouble begins for many home buyers.
Awaken the Responsible Home Buyer Within
By the nature of the many debts and obligations excluded from the debt-to-income ratio; it should be obvious that the lender’s number simply isn’t going to work for you. This is where personal responsibility comes into play. Do not ignore the discrepancy between the lender’s numbers and what you can truly afford. And don’t be discouraged. This is your reality; embrace it and adjust. Look a little harder for a suitable home that fits your budget or perhaps rent until you remove other debts or save for a larger down payment. Do whatever it takes to avoid becoming house poor or worse yet, foreclosing on your new home.
When to Do Your Own Calculations
You can see the importance of running your own numbers before you talk with a lender. Walk into a lender’s office telling them what you can afford and what you are comfortable paying. It is so easy to become “wowed” by your overinflated buying power. As they say “don’t even go there!”
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