Debt-to-Income Ratio –It’s Just as Important as Your Credit Score When Buying a New Home

Your debt-to-income ratio (DTI) is a simple way of calculating how much of your monthly income goes toward debt payments. Lenders use the DTI to determine how much money they can safely loan you toward a home purchase or mortgage refinancing. Everyone knows that their credit score is an important factor in qualifying for a loan. But in reality, the DTI is every bit as important as the credit score.

Lenders usually apply a standard called the “28/36 rule” to your debt-to-income ratio to determine whether you’re loan-worthy. The first number, 28, is the maximum percentage of your gross monthly income that the lender will allow for housing expenses. The total includes payments on the mortgage loan, mortgage insurance, fire insurance, property taxes, and homeowner’s association dues. This is usually called PITI, which stands for principal, interest, taxes, and insurance.

The second number, 36, refers to the maximum percentage of your gross monthly income the lender will allow for housing expenses PLUS recurring debt. When they calculate your recurring debt, they will include credit card payments, child support, car loans, and other obligations that are not short-term.

Let’s say your gross earnings are $4,000 per month. $4,000 times 28% equals $1,120. So that is the maximum PITI, or housing expense, that a typical lender will allow for a conventional mortgage loan. In other words, the 28 figure determines how much house you can afford.

Now, $4,000 times 36% is $1,440. This figure represents the TOTAL debt load that the lender will permit. $1,440 minus $1,120 is $320. So if your monthly obligations on recurring debt exceed $320, the size of the mortgage you’ll qualify for will decrease proportionally. If you are paying $600 per month on recurring debt, for example, instead of $320, your PITI must be reduced to $840 or less. That translates to a much smaller loan and a lot less house.

Bear in mind that your car payment has to come out of that difference between 28% and 36%, so in our example, the car payment must be included in the $320. It doesn’t take much these days to reach a $300/month car payment, even for a modest vehicle, so that doesn’t leave a whole lot of room for other types of debt.

The moral of the story here is that too much debt can ruin your chances of qualifying for a home mortgage. Remember, the debt-to-income ratio is something that lenders look at separately from your credit history. That’s because your credit score only reflects your payment history. It’s a measurement of how responsibly you’ve managed your use of credit. But your credit score does not take into account your level of income. That’s why the DTI is treated separately as a critical filter on loan applications. So even if you have a PERFECT payment history, but the mortgage you’ve applied for would cause you to exceed the 36% limit, you’ll still be turned down for the loan by reputable lenders.

The 28/36 rule for debt-to-income ratio is a benchmark that has worked well in the mortgage industry for years. Unfortunately, with the recent boom in real estate prices, lenders have been forced to get more “creative” in their lending practices. Whenever you hear the term “creative” in connection with loans or financing, just substitute “riskier” and you’ll have the true picture. Naturally, the extra risk is shifted to the consumer, not the lender.

Mortgages used to be pretty simple to understand: You paid a fixed rate of interest for 30 years, or maybe 15 years. As time went on, mortgages started to come in a variety of flavors, such as adjustable-rate, 40-year, interest-only, option-adjustable, or piggyback mortgages, each of which may be structured in a number of ways. Many of these types of loans helped contribute to the mortgage crisis in 2008.

The whole idea behind all these types of mortgages was to shoehorn people into qualifying for loans based on their debt-to-income ratio. “It’s all about the payment,” was the prevailing view in the mortgage industry. That’s fine if your payment is fixed for 30 years. But what happens to your adjustable rate mortgage if interest rates rise? Your monthly payment will go up, and you might quickly exceed the safety limit of the old 28/36 rule.

These alternative mortgage products were fine as long as interest rates didn’t climb too far or too fast, and also as long as real estate prices continued to appreciate at a healthy pace. Make sure you understand the worst-case scenario before taking on one of these complicated loans. The 28/36 rule for debt-to-income has been around so long simply because it works to keep people out of risky loans. As we have gotten further away from the mortgage crisis that helped ruin the economy in the early 2000, lenders are now stretching those ratios based on the strength of the rest of the file.

Make sure you understand exactly how far or how fast your loan payment can increase before accepting a non-traditional type of mortgage. If your DTI disqualifies you for a conventional 30-year fixed rate mortgage, then you should think twice before squeezing yourself into an adjustable rate mortgage just to keep the payment manageable.

Instead, think in terms of increasing your initial down payment on the property in order to lower the amount you’ll need to finance. It may take you longer to get into your dream home by using this more conservative approach, but that’s certainly better than losing that dream home to foreclosure because increasing monthly payments have driven your debt-to-income ratio sky-high.

Debt-to-Income Ratio –- It’s Just as Important as Your Credit Score When Buying a New Home

Your debt-to-income ratio (DTI) is a simple way of calculating how much of your monthly income goes toward debt payments. Lenders use the DTI to determine how much money they can safely loan you toward a home purchase or mortgage refinancing. Everyone knows that their credit score is an important factor in qualifying for a loan. But in reality, the DTI is every bit as important as the credit score.

Historically, lenders have applied a standard called the “28/36 rule” to your debt-to-income ratio to determine whether you’re loan-worthy. Although those numbers have changed, and many of our loans exceed these numbers, it is instructive to use them to explain this concept.

The first number, 28, is the maximum percentage of your gross monthly income that the lender will allow for housing expenses. The total includes payments on the mortgage loan, mortgage insurance, homeowners insurance, property taxes, and homeowner’s association dues. This is usually called PITI, which stands for principal, interest, taxes, and insurance.

The second number, 36, refers to the maximum percentage of your gross monthly income the lender will allow for housing expenses PLUS recurring debt. When they calculate your recurring debt, they will include credit card payments, child support, car loans, and other obligations that are not short-term.

Let’s say your gross earnings are $4,000 per month. $4,000 times 28% equals $1,120. So that is the maximum PITI, or housing expense, that a typical lender will allow for a conventional mortgage loan. In other words, the 28 figure determines how much house you can afford.

Now, $4,000 times 36% is $1,440. This figure represents the TOTAL debt load that the lender will permit. $1,440 minus $1,120 is $320. So if your monthly obligations on recurring debt exceed $320, the size of the mortgage you’ll qualify for will decrease proportionally. If you are paying $600 per month on recurring debt, for example, instead of $320, your PITI must be reduced to $840 or less. That translates to a much smaller loan and a lot less house.

Bear in mind that your car payment has to come out of that difference between 28% and 36%, so in our example, the car payment must be included in the $320. It doesn’t take much these days to reach a $300/month car payment, even for a modest vehicle, so that doesn’t leave a whole lot of room for other types of debt.

The moral of the story here is that too much debt can ruin your chances of qualifying for a home mortgage. Remember, the debt-to-income ratio is something that lenders look at separately from your credit history. That’s because your credit score only reflects your payment history. It’s a measurement of how responsibly you’ve managed your use of credit.

However,  your credit score does not take into account your level of income. That’s why the DTI is treated separately as a critical filter on loan applications. So even if you have a PERFECT payment history, but the mortgage you’ve applied for would cause you to exceed the 36% limit, you’ll still be turned down for the loan by reputable lenders.

The 28/36 rule for debt-to-income ratio is a benchmark that has worked well in the mortgage industry for years. Unfortunately, with the recent boom in real estate prices, lenders have been forced to get more “creative” in their lending practices. Whenever you hear the term “creative” in connection with loans or financing, just substitute “riskier” and you’ll have the true picture. Naturally, the extra risk is shifted to the consumer, not the lender.

If your DTI disqualifies you for a conventional 30-year fixed rate mortgage, you should think twice before squeezing yourself into an adjustable rate mortgage just to keep the payment manageable.

Instead, think in terms of increasing your initial down payment on the property in order to lower the amount you’ll need to finance. It may take you longer to get into your dream home by using this more conservative approach, but that’s certainly better than losing that dream home to foreclosure because increasing monthly payments have driven your debt-to-income ratio sky-high.

The 7 Worst Financing Mistakes First Time Home Buyers Make…And How to Avoid Them, A Free EBook

I am excited to release my new EBook for first time home buyers: The 7 Worst Financing Mistakes First Time Home Buyers Make… and How to Avoid Them.

Click here or on the picture on the right to download your free copy.

Having originated mortgages for close to three decades, I have found the topics covered in this EBook are the ones first time home buyers want to know about most. Hopefully, this EBook will help you avoid the mistakes others have made that have cost potential home owners thousands of dollars, and blown up many deals.

Here are some of the mistakes I cover in this easy read, that will help you avoid a similar fate:

  • Overextending yourself
  • Not counting the cost of bad credit
  • Not knowing your down payment options
  • Not budgeting for closing costs
  • Not getting pre-approved
  • Not choosing the right mortgage product
  • Not getting multiple lenders to compete for your business
  • and so much more…

The download is absolutely free as my gift to you for reading my blog; there is nothing to buy and no commitments to make. Enjoy it, and feel free to pass it on.

I wish you much success on your purchase.

Follow These 5 Steps to Make Your Home Buying Process Smooth and Easy

There are few purchases in life that carry the financial and psychological weight of buying a home. Whether you are buying your first home, moving up to your dream home, or downsizing your home and your life after the kids have gone, it is important to understand the ground rules for success in the world of buying a home.

Making the wrong decision in buying a home can have devastating and long lasting effects, while making a wise decision in home buying can greatly enhance the overall value of the investment. It is necessary to learn all you can about the world of home buying and mortgages before setting out to purchase the home of your dreams.

While there are plenty of web sites designed to help first time homeowners learn all they can, most financial experts say that there is no substitute for good old one-on-one learning; the kind you will get with am experienced real estate agent and mortgage broker.

When buying a home it is often best to use a systematic approach as this is often the best way to be sure that all decisions are based on information and reason, not on impulse or emotion. Buying a home can be an emotional process, nevertheless it is imperative to keep your emotions under control and not let them cloud your judgment.

There are five basic ground rules when it comes to buying a home and shopping smart:

#1 – Get Pre-Approved for Your Mortgage First

There are few things in life as disappointing as losing out on the home of your dreams due to not being able to secure funding. While the desire to get out there and search for that great home is understandable, it is vital to know if you can secure the financing you will need before you start shopping for a home.

Pre-Qualifying for a home ahead of time has a number of important advantages, including knowing how much you can buy and gaining more respect from the seller. By knowing how much home you can afford before you shop, you will avoid wasting your time looking at unaffordable properties.

It is also important to take a good look at the various types of mortgages on the market before getting started in the home buying process. The mortgage market has changed, so potential home buyers need to understand how each type of mortgage works, and to gauge which mortgage is the best choice for their needs.

#2 – Look at the community, not just the home

It is a good idea to look at the entire community, instead of focusing on a single home. This can be a particularly important thing to consider for those moving to a new metropolitan area, as these buyers will be unfamiliar with the local climate and lifestyle. It is crucial to determine the areas of town that are most desirable, and to consider things like distance from work and local shopping opportunities.

We have all heard that location is the key consideration when it comes to real estate, and that is certainly the case. Buying a house in the wrong area can be a big mistake, and it is important to choose the location as well as the home. Potential buyers can learn a great deal about the nature of various neighborhoods simply by driving around town, as well as by talking to other residents.

#3 – Be fair with your first offer

Trying to low-ball a seller on the first offer can backfire, as can paying too much. It is important to carefully evaluate the local market, and to compare the asking price of the home with what similar houses in the neighborhood have sold for.

Comparing the sales of comparable homes, what are known as “comps” in the industry, is one of the best ways to determine what is fair, and to make sure that you neither overpay or underbid on the property.

#4 – Always get a home inspection

Always investigate the home for any possible defects before making an offer. Compared to the cost of the average home, the price of a quality home inspection is virtually negligible. Make sure to get a good home inspection done before you buy.

To find the best home inspector, it is a good idea to seek out word of mouth referrals as many of the best home inspectors rely on word of mouth advertising.

#5 – Do not alienate the sellers of the home

Many real estate deals have fallen apart due to the personal animosity of the buyer and the seller. It is important to avoid alienating the seller of the home during the process, and to avoid nitpicking every little detail during the sale. Having a good real estate agent on your side will create the proper buffer between yourself and seller, and make for a much smoother process.

Check out my new EBook: “The 7 Worst Financing Mistakes First Time Home Buyers Make and How to Avoid Them.” Just click on the link on the right for your free EBook.

Pre-Qualified vs. Pre-Approved When Buying a Home

These days, getting a letter or post card in the mail that says “Congratulations! You have been Pre-Approved or Pre-Qualified for a mortgage,” are as commonplace as the numerous credit card offers that we all receive, and they are worth the paper they are printed on.

Having a Pre-Approval from a lender or broker in your pocket, will greatly improve your chances of buying the house you want.

Here are some important facts about Pre-Approval for mortgage loans..

Apply before you buy

Although many people used to look at homes before applying for a mortgage loan, nowadays it is critical that you apply for a mortgage Pre-Approval first. This will allow you to know exactly how much you can afford to spend on a house, and find the property you want much more quickly and easily.

Pre-Approval vs. Pre-Qualification

There is a great deal of confusion between these two terms. To be Pre-Qualified simply means that based on your income and debt and the amount of cash you have for down payment and closing costs, assuming your credit meets the standards of the lender, you are qualified to apply for a mortgage loan at today’s interest rates. A Pre-Approval letter is different.

Obtaining a Pre-Approval letter

In order to obtain a Pre-Approval letter with most lenders or brokers, you fill out a mortgage application form listing your income and assets, and a credit report is run. Some lenders may ask for additional documentation, while others will issue a Pre-Approval subject to receipt of documentation to substantiate what has been filled out on the application. Once you receive your Pre-Approval letter, you can start shopping for your new home.

Looking at the right homes

If you have a Pre-Approval letter, you know exactly how much you can afford to spend on a property, and can narrow your search down to homes within this price bracket. This will help you to find a property to match your needs much more quickly, and make buying easier.

More negotiating power

If you have a Pre-Approval on your mortgage loan, you will be seen in the same way as a cash buyer. You already have the funds in place, so the seller is more likely to accept an offer immediately, even if it is below the price estimate. This is because they can be more certain that their house is sold, and can take it off the market pending the close of sale.

Quicker sale closing

One of the lengthiest parts of house buying and selling is the closing of the sale. If you have agreed to buy a house but do not have a mortgage in place, then it can take time to arrange the funds, and you might even find that you cannot get the funds you need. However, if you have a Pre-Approval, the funds are essentially guaranteed, and you can push through the transaction much more quickly. This will make buying a house much less stressful, and help you to get the home you really want.

3 Hot Tips To Boost Your Fico Score

Building a good credit score is a long term process. As they say, a journey of a thousand miles starts with the first step. Beware of quick fixes. There are none except for the quick fix of getting into your wallet by way of a scam, and there are some out there. Here are three hot tips to boost your credit score.

Today, one of the biggest components of your FICO score is the percentage of available credit you are using. This is also known as your Utilization Ratio. The traditional way of course is to pay down your accounts to improve the percentage. The higher the percentage the lower the score. There is another way.

1. ASK FOR CREDIT INCREASES:

This achieves the same result-decreasing the percentage of credit used. Just be careful not to use the new found “wealth”. That is like shooting yourself in the foot. Be careful not to ask for too much of an increase.

2. PAY OFF YOUR BILLS:

Pay them off not when they are due but before they are due. Find the statement date (usually 20 or so days before the due date) and pay it off a day or so early. That brings your account balance to zero dollars, thus increasing the percentage of available credit. If you pay the bill on the due date it will not have the same effect.

3. DON’T TOSS THOSE OLD CARDS:

Many have found out about this one the hard way. If you are not using an old card for any reason do not throw it away. Take advantage of it and charge small amounts occasionally. This results in an active vs. an inactive status for that account. Active accounts are factored into the FICO scoring system-inactive accounts are not.

Using these three hot tips will boost your FICO score almost overnight. Take the knowledge and run with it, and improve your score today.

Beg, Borrow or Steal, But Make That Mortgage Payment

One of the most common things I hear when a prospective client contacts me for a mortgage refinance is “I just missed a mortgage payment and I want to refinance before it’s too late”. When I ask them about their credit, most of them reply “Oh I pay everything on time, I just got behind this one month on the mortgage”.

It breaks my heart to tell them that in many cases, it already is too late. The reason is simple if you really think about it: If your home is your biggest investment, your greatest potential asset and your largest current liability, there is nothing more important than showing that you are able to make the payment on it every month. If you are in a cash crunch, you’re better off missing or underpaying almost any other payment, such as a credit card bill, even your utility bill, instead of missing or even delaying your mortgage payment, because missing one mortgage payment can cost you tens of thousands of dollars over the years.

When you miss a mortgage payment, your credit score may not go down dramatically. But your mortgage credit quality will take a serious beating, and you’ll carry it around for years. When you start out with a mortgage, regardless of what your FICO credit score is, you are rated an “A”, meaning you make your mortgage payments on time. If you miss a payment, and even if you’re just late enough to qualify as 30 days late, the lateness is recorded and you will become an “A-” or a “B”. Just one mortgage lateness can keep you out of the refinance market for up to two years by automatically locking you out of the lowest payment programs. If it sounds a bit like high school, it is, but this time it’s for keeps. Keep missing or delaying payments, and you’ll quickly see your mortgage quality decline to a “C” or “D”, which could prevent you from refinancing entirely, by eliminating your eligibility from even standard rate programs.

This hurts the most when you refinance or are ready to buy a new house, because you are usually borrowing more money than you were previously, either to pay off bills or make home improvements, or because you’re buying a bigger house. So not only are you moving to a higher balance, but your now derogatory mortgage credit will force you into a high rate. If you need the cash to pay off bills and improve your credit urgently, or to purchase a home in a new area because you are relocating for work, you can wind up in a horrible Catch 22, very often disqualified for financing entirely, or with financing so unaffordable that you would rather not.

So what can you do about this? If you do better with automatic payments, sign up for direct debit payment with your lender, or arrange for your bank to automatically pay your mortgage every month on a specific date far enough ahead of the due dates for your other bills, so you won’t be tempted to pay something else. The day after payday is a great day to do this. And the date should be far enough ahead of your due date that the bill is paid and posted on time. It might hurt that first month, but it will even out once you get used to the new schedule.

No matter what, make sure you satisfy your mortgage payment obligation. Most everything else on your credit report can be repaired or negotiated, but not your mortgage lates. Don’t wind up in a situation where you’re ready to dance but too late to the party. Plan ahead, and as always, protect your financial future today.

Life After Bankruptcy: Yes, You Can Get a Mortgage!

It’s possible to put your credit back on track and qualify for a mortgage, even after bankruptcy.

Sometimes bad financial situations happen to good people and bankruptcy is the only way out. But it’s not all doom and gloom! It’s possible to put your credit back on track and qualify for a mortgage, even after bankruptcy.

Here’s how:

• Find the right lender. Unlike mainstream lenders, non-conforming lenders will usually provide financing after a bankruptcy, if you can demonstrate that you’re now a good credit risk and have sufficient income. I can help you with that.

• Wait a couple of years. Most lenders won’t approve a mortgage until two years after bankruptcy.

• Have a good reason. If bankruptcy was due to factors beyond your control, you’re more likely to get a mortgage. Reasons such as poor money management and excessive debt aren’t looked at favorably.

• Save a down payment. Most lenders will consider a 10% down payment (your own funds, not borrowed or a gift), or even 5% in some instances. However, the higher your down payment, the lower your interest rate will be.

• Re-establish good credit. Get a copy of your credit report from Equifax, Experian or Trans-Union, and work on building a recent record of on-time payments on major bank or credit cards. Missing a payment at this stage could lead lenders to decline you. By rebuilding your creditworthiness, you can raise your credit score, which will lower the rate you’ll end up paying.

• Work to keep your rate low. Most lenders charge a higher rate for previous bankruptcies, and some charge extra fees. You can keep your rate as low as possible by waiting for two years after discharge, re-establishing good credit, raising your credit score, saving your own down payment, maintaining good debt servicing ratios, and demonstrating a long term history of job stability.

• Don’t do it alone. As your mortgage professional, I can coach you on how to improve your credit score over time and help you source an affordable mortgage despite bruised credit. If you—or someone you know—would like a free, no obligation consultation, call me today!

Basic Mortgage Terms You Should Know When Buying a House

Understanding these terms will allow you to avoid many of the pitfalls that exist in the real estate market

Educating yourself on the various mortgage terms you will run into will help you make better decisions when deciding which home you want to purchase. When you sign a mortgage contract, your home is used for collateral and it is your responsibility to make sure your payments are made on time each month.

The first term you should know is principal. The principal is basically defined as the amount of money you borrow for your home. Before the principal is provided you will need to make a down payment. A down payment is the percentage you will put towards the principal. The amount of the down payment will often depend on the cost of the home. Once you pay off the principal, the home is yours.

The next term you will need to know is interest. Interest is a percentage that you are charged to borrow a certain amount of money. Along with the interest rate, lenders may also charge you points. A point is a portion of the total funds financed. The principal and interest makes up the majority of your monthly payments, and this is a method that is called amortization. Amortization is the method by which your loan is reduced over a given period of time. Your payments for the first few years will cover the interest, while payments made later will be applied towards the principal.

A portion of your mortgage payments can be placed in an escrow account in order to go towards insurance, taxes, or other expenses. The next term you will hear a lot is taxes. Taxes are the amount of money that you have to pay to your state or government. When it comes to your home, these are known as property taxes. These taxes are used to build roads, schools, and other public projects. All homeowners must pay property taxes.

Insurance is another important term that you will hear in the real estate community. You will not be allowed to close on your mortgage if you don’t have insurance for your home. Home insurance covers your home against floods, fire, theft, or other problems. Unless you can afford to repair your home if it is damaged, it is usually a good idea to get insurance for your home. If your home is located within a zone that is known for having floods, federal laws may require you to have flood insurance.

If the down payment you put towards your home is less than 20% of the total value, you will often be charged additional premiums on your insurance by the lender. This is done to protect you in the event that you default on your loans and fail to make payments. Without this, many people would not be able to afford a house.

These are the basic terms you will need to know before your purchase a home. Understanding these terms will allow you to avoid many of the pitfalls that exist in the real estate market. You want an interest rate that is low, and you should always try to get a fixed interest rate if possible. This will allow you to focus your income on making payments towards the principal, and this will help you pay off the loan faster. A mortgage is an important part of your financial picture, and you want to make sure you pick a home that you can afford. If you fail to make your payments, you may lose your house.

7 Tips for Establishing Credit for Home Equity & Mortgage Loans

Your credit score will always be a key ingredient for low interest rates when qualifying for a mortgage or home equity loan.

According to Experian, a credit score is a number lenders use to help them decide: “If I give this person a loan or credit card, how likely is it I will get paid back on time?” The information from your credit reports is used to create your credit score. Your credit score will always be a key ingredient for low interest rates when qualifying for a mortgage or home equity loan.

Before applying for a mortgage or home equity loan, get your free credit report from each of the three major credit reporting agencies (CRAs): Experian, Equifax, TransUnion. Under federal law, you are entitled to one every year. Order online at annualcreditreport.com, or call 1-877-322-8228. Check to make sure someone else’s information isn’t mixed into your report. If so, contact the CRA immediately and have them delete it.

Then, follow these tips to help you establish credit and build your credit score:

1. Establish checking and savings accounts and maintain them responsibly.

2. Piggyback on someone else’s good credit by being added to a credit card as an “authorized” (joint) user.

3. Get someone to co-sign a loan for you (e.g., financing a car, or other secured loan) and make your payments on time.

3. Apply for student loans and make your payments on time.

4. Apply for a credit card or a secured card. Make sure the issuer reports to all three CRAs, otherwise the card won’t help you build your credit.

6. Apply for one gas card and one department store card to add to your credit mix.

7. Use your credit cards regularly, but wisely. Make all payments on time because the two most important factors in your score are whether you pay your bills on time and how much of your available credit you actually use.

Establishing and maintaining good credit will make buying a home a lot easier for you. You’ll be able to get a good fixed rate loan instead of having to settle for a variable rate subprime loan. It will also help for times you may need a home equity line of credit for home improvements or a home equity loan for debt consolidation, including paying off student loans.