In the previous installment of this 2-part series, I discussed how you can prepare yourself for a mortgage application in terms of your credit report and credit score. In this installment I’ll talk about most lender’s criteria for lending to you.
Where can you get a mortgage?
You may obtain a mortgage from a commercial bank, a savings and loan institution, a mortgage company through a loan originator, or even a private individual.
How much will they lend you?
To answer that, let me give you a term and define it. The term is PITI: Principal, Interest, Taxes, and Insurance. PITI is, in other words, the out-of-pocket expense that it takes to keep you living in the home you buy. PITI also includes association maintenance or condo fees.
Mortgage qualifying ratios
Lenders use two qualifying ratios in determining how much mortgage you can afford. They will loan you 28% to 36% of your monthly gross income for PITI expenses, and 36% to 41% of your gross income for PITI plus other debt expenses. These qualifying rations will vary by lender and market, and may be significantly higher depending on the specific financial situation of the borrower. In some cases this may be as high as 50%, but not everyone qualifies for this. In this post, we’ll assume a lender wants you to demonstrate that you can afford 28% in PITI expenses and 36% of PITI expenses AND debt expenses.
Getting approved for a mortgage
Picture this scenario: Say, to make the math easy, you earn $120,000 gross – not take home, but gross.
That is $10,000 per month. Your bank wants to see that no more than 28% of that, or $2800, would be spent on PITI. That means between the mortgage payment itself, insurance on the house, property taxes, and any condo or association fee all taken together would come under that amount. Your bank also uses 36% for the second ratio. That means that $3600, to continue our example, would have to cover PITI plus your car payment, student loan payment, Nordstrom bill, and so on.
PITI expenses when applying for a mortgage
Say you wanted to purchase a home that cost $400,000, putting 20% down, and you can obtain a mortgage at 3.5% for 30 years. Here are some numbers to plan ahead:
$1,437 monthly principal and interest
$150 homeowner’s association
$310 property taxes
Monthly your expenses are $2137. You qualify under the 28% ratio, as your expenses are only 21.37% of your monthly gross.
PITI and debt expenses
Now let’s see how the 2nd ratio, the 36%, comes into play.
Let’s say you have these additional expenses:
$750 student loan
$500 car payment #1
$650 car payment #2
In this scenario, your monthly expenses are $4112, or 41.12% of your monthly income, exceeding the 36% ratio.
Would exceeding qualifying ratios prevent mortgage qualification?
Maybe. It depends on the lender. It may if your credit scores are not strong. If they are strong, however, there is usually some leeway. See my last post on building your credit score. You always have the option of adding more to the down payment, so that the monthly loan payment would decrease. What else could you do? Pay off the Nordstrom balance. Sell one of the cars and get something with a lower payment. Or shop for a cheaper house.
Is a 20% down payment necessary?
No, but it will keep your interest rate down. Also, on conventional loans you won’t need to purchase mortgage insurance if you plunk down enough cash. In the previous example I used 20%, but in actuality you probably don’t need that much. If you are a veteran, you could qualify for a VA loan with little if no money down. First-time home buyers need only put down 3%. Qualifying people for mortgages is its own specialty. You will be in a much stronger position if you take the time to do the following well before applying for a mortgage:
Check your credit report at annualcreditreport.com and verify accuracy
Do what is necessary build up your score
Save what you can for a down payment
Maintain a working budget so you can afford to stay in your home
In that budget, you’ll want to re-analyzing your federal tax situation to see how much tax you are saving after a home purchase. Generally, once you have a mortgage and pay property tax, you qualify for itemized deductions. This could save you a lot of money on your federal taxes. That could, in turn, increase your take-home pay.
We made a short, but concise, video on preparing for a home purchase. For more on this and other financial planning topics, be sure to explore the CameronDowning website. Connect with us on Facebook, LinkedIn, and Twitter. We look forward to meeting you in the future