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Purchase Mortgages Part 2: How much can I afford?

When a mortgage lender qualifies a borrower, they will examine income and monthly debts to establish a debt ratio. If you are wondering what a debt ratio is, and how it is calculated, take a look at this graphic and read on.

Mortgage Debt Ratios

A debt ratio compares monthly debts to income and then generates a number that is usually converted to a percentage. If your debt ratio is too high, you may not qualify for certain loan programs…or worse, may not qualify for a loan at all!

Lenders will typically run two different debt ratio calculations. The “front-end” ratio will examine all debts except for your housing payment. The “back end” ratio will examine all debts and include a soon-to-be housing payment.

For the purpose of this introduction, the graphic below considers only the “back-end” ratio which includes the soon-to-be mortgage payment in the calculation.

Let’s also take a look at an example. Assume you earn $5,000 each month and have a student loan payment of $400 and a car payment of $250 each month as well.  Your front end ratio will be $650/$5,000 = 13%.  This number is far below the typical requirement of 31% for FHA loan front end ratios.

Now consider adding in your new housing payment (including the mortgage payment, taxes, insurance, and mortgage insurance) of $1,500.  Including this debt will generate a back end ratio of ($650 + $1,500)/$5,000 = 43%, the limit for most FHA back-end ratios.

Tip: Remember to use gross income when it comes to calculating a debt ratio. Gross income is the amount of income BEFORE taxes and other items, such as health insurance or 401k contributions, are taken out. 

In part one of this series, we learned a bit about the relationship between the purchase price, down payment and loan amount of a purchase mortgage. Now that we have a better understanding of debt ratios, we will take a look at what actually makes up a mortgage payment – and it may be more than you think!

Related Posts in this Series

Part 1: What is a mortgage? 

Part 3: What makes up a mortgage payment?

Purchase Mortgages Part 1: What is a mortgage?

If you are looking to purchase a home this spring or summer, you may be searching for an easy way to learn about your mortgage options. Or, you may be wondering what a mortgage is and know nothing about them at all!

Regardless of your current knowledge base, a quick primer on purchase mortgages can save time, money and quite a bit of frustration!

In this series of posts, we’ll cover three concepts using real numbers and supporting images. The goal is to give you a clear understanding of purchase mortgage basics – so you can easily apply new learnings as you continue your journey! Now, let’s get started!

What is a mortgage?

When it comes to purchasing a home, you’ll need to pay the current property owner for the home and cover the related costs associated with the sale transaction. Understanding how the closing costs, down payment and loan amount are related to the home sale price is an important first step in understanding purchase mortgage options. 

If you are looking for a more technical definition, please read on.

A mortgage is legal document that creates a lien on a property after an agreement is reached between a lender and a borrower. The mortgage is recorded as a public record document at the local county’s office and secures the subject property as the collateral in consideration for a loan. 

Now that we know a bit more about the cash needed to buy a home and how those funds will be allocated, it is time to examine home affordability by taking a look at something called a debt ratio.

Next Up

Part 2: How much can I afford? 

Part 3: What makes up a mortgage payment? 

Prequalification letters: How they help you, your Realtor and the seller

If you are searching for a home this spring, you’ll need a prequalification letter to prove you have your finances in order. Without one, your offer to buy a home is likely to fall flat, very flat.

So, what is a prequalification letter (aka “prequal”) and why is it so important? Let’s take a look at three different perspectives to understand how this one document can play such an important role in kicking off a real estate transaction.

Prequalification letters guide the mortgage borrower

The term “mortgage borrower” refers to you. When you purchase a home, you will likely require a mortgage and therefore, you will become the mortgage borrower. So how much can you actually borrow?

While we could break out the calculators and scratch paper (or Excel), there is no need to because the lender handles it all. Said another way, the lender that prequalifies you will ask a series of questions and obtain your credit report. This process allows the lender to create a prequalification letter that includes, among other things, your maximum loan size.

Note: While the maximum loan size is great to know, please do not confuse it with being anything other than just that – a maximum. Be sure to budget your own finances to ensure you can comfortably manage your new monthly mortgage payment.

In summary, a prequalification letter for a mortgage borrower provides the confidence to know (preliminarily) that they can qualify for the mortgage amount needed to purchase a particular home.

Realtors identify serious shoppers

Having a prequalification letter in hand when first connecting with a Realtor indicates you have done your homework and are a serious shopper. Without a prequal letter, there is virtually no way for a Realtor to confirm (or deny) your ability to purchase a home.

This is important because a Realtor has just 24 hours in a day and 7 days in a week (just like you and me). Despite the fact that the best Realtors make us feel like we are their only clients, they are often juggling multiple transactions simultaneously.

Realtors need to be selective with their time. Home shoppers that show up with a prequal in-hand will always get more attention than those that show up empty-handed.

Sellers look for prequalification letters

We are currently in a seller’s market, where high competition exists for a limited supply of homes. Based on this, home sellers will likely receive multiple offers from a range of prospective buyers.

When a seller receives multiple offers simultaneously, one would think that the highest priced offer always wins. While that may typically be the case, other factors, such as down payment amount, loan program selection and other contingencies are also compared to determine the likelihood of a smooth transaction.

Tip: Contingencies are conditions that must be met prior to the sale of a property.  While many contingencies are negotiable, standard ones include a buyer’s home inspection and the buyer successfully obtaining a loan or financing to purchase the property. 

When a seller is evaluating a range of offers, any offer lacking a prequalification letter will be devalued regardless of the purchase price offered. As a matter of fact, it is virtually a requirement these days that an offer to purchase a property include a prequalification letter.

Related posts:

Wondering if all Lenders offer the same interest rate? Look here.

Concerned about increasing interest rates? Look here.

3 must do’s after a weekend of house hunting

It’s Monday…and you’ve just had an exhilarating weekend of house hunting. You’ve seen the good, the bad, and just about everything else while driving all around town. Some of the properties you just walked through may already be under contract – so you can cross them off your list!

A weekend of house hunting can be quite discouraging in a seller’s market. So how can you keep your head up when you feel like you are fighting a losing battle? Do these three things each Monday – and you’ll be ready to act when the time is right.

Catalogue the properties you viewed

Document the property address, style of home, list price, best attributes & other important details. Ask yourself this question: What kept you from being interested in the property or what made you want it?

By doing this, you’ll find that certain property features will come to the surface as most important. This will help guide your future searching and make you more confident (so you can act more quickly next time).

Check in with your Realtor

Contact your trusted Realtor to talk through the properties that were most attractive to you.  After learning of a small price change or other information, a “maybe” on your list could turn into a “yes!”

If you do find yourself interested in a property, the time to act is now. You can request a second showing or cut to the chase and get a purchase contract written up! Remember, you aren’t the only one eyeing that property in this seller’s market – so act quickly.

Stay current on mortgage rates

Interest rates change at least every day, and can swing drastically over the course of a week. A small change in interest rate can make a BIG difference in monthly payment – so staying up to date on available mortgage rates and programs is a must!

For example, the monthly payment on a $350,000 mortgage will drop by $26 if rates are just 0.125% lower! That’s a savings of $312 a year – or about one free car payment!

Just as it is important to shop lenders early in the process, it is also important to keep your knowledge level up as you hunt for that perfect home. After all, a dip in mortgage rates will make all homes more affordable.

Related posts:

What is a seller’s market? Look here.

Concerned about increasing interest rates?  Look here.

All mortgage companies offer the same interest rate…RIGHT?

TRUE or FALSE: There is “one rate” that all mortgage companies offer on any given day. 

Today I met with an owner of an insurance agency. After seeing that interest rates varied by as much as 0.375% between lenders for the same loan, he said: “I thought there was one rate for mortgages on any given day?”.  He admitted that he knew fees could be different, but had no idea that the actual interest rate could vary as well.

Surprisingly, he’s not alone.

While interacting with financial advisors, insurance agents and even real estate agents, we have learned that there is a great opportunity to provide education in this space. For one reason or another, professionals outside of the mortgage industry tend to have surprisingly little knowledge of the mortgage market & process. This may make sense as they don’t “do” mortgages, nor do they receive compensation on them, but it is hard to argue that mortgages are not relevant in the world of financial planning….or real estate for that matter!

The truth is that rates WILL vary between mortgage lenders (as will fees, the personality of the loan originator, the speed at which they can close your loan and the technology in place).  What remains consistent in all mortgage situations is this:

Your choice in a mortgage lender will have a lasting impact on your finances.  

The few weeks it takes to complete a mortgage loan will result in a new debt payment – one which is determined based largely on the interest rate you select (in addition to loan term, loan amount and other factors).  When all else is equal – a higher interest rate means a higher payment for the same mortgage amount. So consider the long-term impact of a loan’s rate – not just a perceived “ease” of a transaction in the short term.

If you are looking for some helpful hints to keep you sane as you wrangle the mortgage shopping process, here are two suggestions:

Don’t fall victim to technology

Ask yourself: Would you complete a paper application if it meant saving $50 to $100 every month for as long as you owned your home? If so, then don’t let an “app” guide you astray. Despite what certain companies want you to think, the mortgage process isn’t really that hard (it’s more of an inconvenience). Regardless of how you obtain your loan, you’ll be left with a monthly mortgage payment for 120, 240 or 360 months. The mortgage process, itself, is a short-term inconvenience at most.

Protect your personal contact information

If you have ever entered your phone number on a mortgage shopping site before, you likely received multiple phone calls every hour for days. Chances are you will NOT do that again. There are plenty of ways to learn about mortgages in a safe way. MortgageCS allows you inquire about specific loan programs and even interact with loan officers directly – without giving out this private information.  As a result, you remain in control of the contact process and once you find the best fit – you can then decide to share these details.

In closing, and just in case it hasn’t been obvious yet, mortgage rates CAN & DO vary significantly between mortgage lenders for several reasons.  To be safe, take your time, and ensure you end up with a great deal by focusing on the end goal. Using MortgageCS keeps it straightforward and simple, so get started today at MortgageCS.com.

3 ways to keep your payment the same when rates are on the rise

When it comes to mortgages and the home buying process, interest rates are almost always front and center. This is not a surprising thing, as nothing else impacts the housing market quite like a quick rise (or drop) in mortgage interest rates.  Additionally, mortgage interest rates are one of the most commonly compared terms when consumers shop lenders and loan officers.

For most first time buyers, sticking to a budget is essential. So what is one to do when rates suddenly increase?  Well, there are a few options – some a bit easier to consider than the others.

Look for smaller homes in the same area

If your heart is set on purchasing a home in a particular area, interest rates have recently increased AND you are on a fixed budget, there is little you can do but search for a lower priced home. If you were looking for a townhouse, this may mean you need to reduce the bedroom and bathroom count or perhaps even switch to consider condominium units. You may no longer be able to afford a home with the upgrades you hoped to include or perhaps you can no longer afford the unit with a basement or garage.  In either case, some level of sacrifice will need to be made as the macro-environment of interest rates increases.

Look for homes in a less expensive area

Maybe your heart isn’t set on buying a home in a particular area – but rather the home’s amenities are front and center. If this sounds like you, then it may be easy to consider a home in a different school district, township or even over state lines (if applicable). Keep in mind that the school district can be a very important factor in reselling a property – so a bargain price today may be more difficult to sell in the future (and may appreciate at a slower rate overall).

Delay buying until next year

No real estate professional wants to see you delay the purchase of a home – and perhaps you don’t want to either. However, if you are set on a certain property type and location for your new home, this may be the most viable option provided that you can save money at a rate that will outpace the appreciation on the home and any subsequent increases in interest rates. Note: This may be a HUGE amount and ultimately be unknown until a time in the future. 

Keep in mind there are some significant risks with delaying the purchase of a home. First, the interest rate environment is largely unpredictable and rates could increase further – actually making the home less affordable next year.  Second, home prices could increase which translates to you spending more over the life of your loan, and missing out on a year’s worth of home value appreciation. Third, there is no way to know what the home inventory may look like.  If there are homes you would consider purchasing today, there is no way to guarantee the inventory will be available next year (Just ask anyone that wanted to buy a house in 2016 and waited until 2017 when inventories were down 40%!).