Mortgage Lending

When someone is ready to buy, they often hop in their car and start browsing the local housing stock for their new home. It can be an exciting venture, especially when you’ve found a few in your price range.

But what is your “price range,” really? Do you know what that corner dream house with the covered patio and finished basement will cost you each month? The truth is, the sticker price in the homebuyers guide is just a part of the total housing cost and doesn’t take into account all the other costs and criteria that a lender will be considering when you apply for a mortgage loan.

There are distinct questions a lender has to answer before they can determine what a mortgage payment is going to look like. We’ll discuss these elements over the next couple installments, but for now… we will start at the beginning.

What Drives a Lending Decision?

The first step in the process is to apply for a mortgage loan. Unfortunately, not everybody qualifies for mortgage loans, and a lender has to deny applications. There are three criteria that lenders consider for every loan application:

  • Credit Score/Profile
  • Debt to Income Ratio
  • Funds to Close

Funds to Close include your down payment, hard costs (closing costs), and soft costs (prepaids). We will discuss all of these a little bit later. For now, let’s focus on Credit and Income.

Your Credit Score, or your FICO score, is based on information contained in your credit report. Scores range from 350 to 850, with 723 being the median score in the U.S. (Zillow.com). The higher your score, the better your mortgage interest rate/terms. You can usually expect the best terms if your score falls within 720 to 760.

Five things determine a credit score:

  • Payment history – Are you paying your bills on time?
  • Amount owed – What is your overall debt and how does it compare to your total credit available?
  • Length of credit history – How long have you been borrowing money? The longer you’ve been borrowing, the better.
  • New credit – Have you applied for new credit?
  • Types of credit used – Having a variety of credit is best, such as bankcards, car loans, student loans, etc.

Most lenders use your FICO score as a means to determine your interest rate and what type of loan you qualify for. Most homebuyers qualify for an FHA loan with a score of 620 or higher. Fair credit ranges from 620 to 659, Good is 660 to 719, and Excellent is 720 and up. My team is available to help coach/teach credit score & credit profile concepts.

Get Your Free Credit Report

You get one free credit report annually from each of the three reporting bureaus: Equifax, Experian, and TransUnion. Take advantage of this and get your report BEFORE you start house hunting. This will give you time to go over your report and check it for inaccuracies, or improve your score if it’s too low.

If your report is out-of-date or inaccurate, contact the reporting bureau via email, telephone, or letter. Your information will be tagged as “disputed” until the issue is resolved. Disputes are required to happen within 28 days (1 month).

If your credit information is accurate, there’s no way to change it. However, you can take steps to make it a little bit better:

  • Voters’ Roll – Ensure you’re recorded on the electoral roll at your current address to affirm that you live where you say you do.
  • Credit Accounts – Ensure payments are up-do-date on your accounts, and that any late payments are settled.
  • Credit Applications – Avoid making multiple applications for credit. Searches are on record for up to two years, and having many searches out there can be a red flag for either desperation or potential fraud.
  • Provide Full Address History – Always provide your address in full when asked. Omission can be a red flag for potential fraud.
  • Court Judgments – Ensure any past judgments are paid off and marked as “Satisfied.”
  • Notice of CorrectionCan be added to entries on your report to explain late payments or gaps in your credit history.
  • Address Links Ensure links to other addresses are accurate and true. Query any you’ve never been connected to.
  • Financial Associations Ensure any connections with other people are correct. If they no longer exist, ask for them to be removed.
  • Aliases Ensure the list of aliases is accurate and true.

And remember, the easiest way to build credit is to use your credit cards responsibly. Using them for purchases that you know you can afford to pay off quickly is a great way to build credit, but be cautious not to live on them. Credit card debt can go from Benefit to Burden pretty darn quick if you’re not careful. It is a difficult burden to get out from under…be smart.

How Much House Can You Afford?

Along with your credit history, lenders are interested with your monthly gross income and how much cash you can put down on the house. They determine this by figuring out your debt-to-income ratios. They do this two ways.

First, they consider your housing expense ratio, or your front-end ratio. This shows how much of your gross (pretax) monthly income would be put toward your mortgage payment. Typically, your monthly mortgage payment, which includes principal, interest, real estate taxes, and homeowners insurance, shouldn’t exceed 30% of your gross monthly income. You can figure out your maximum housing expense ratio with the following equation:

Annual salary x 0.30 / 12 (months) = Maximum Housing Expense Ratio

Your back-end ratio, or your total debit to income ratio, shows how much of your gross income goes toward your other debt obligations, such as mortgage, car loans, child support, credit card bills, and student loans. This shouldn’t exceed 43% of your gross income, and you can calculate your maximum with a similar equation:

Annual salary x 0.43 / 12 (months) = Maximum Allowable Debt-to-income Ratio

Example:  your household earns about $80,000 per year. Your maximum monthly mortgage payment based on those guidelines would be $2,000. Additionally, your maximum allowable debt load would be $2,867.

Figuring out these numbers is the first step to take when determining what you can afford for a house payment. Different types of loans yield different debt ratio requirements, and lenders will also take into consideration Real Estate Taxes and Homeowners Insurance. I’ll discuss more in the next installment.

 

*Not intended as credit counseling, accounting or investment advice. Contact your financial representative for more information.