Tag: Buying a House

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7 Reasons Your Mortgage Application Was Denied

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

There are few things more nerve-racking for homebuyers than waiting to find out if they were approved for a mortgage loan.

Nearly 627,000 mortgage applications were denied in 2015, according to the latest data from the Federal Reserve, down slightly (-1.1%) year over year. If your mortgage application was denied, you may be naturally curious as to why you failed to pass muster with your lender.

There are many reasons you could have been denied, even if you’re extremely wealthy or have a perfect 850 credit score. We spoke with several mortgage experts to find out where prospective homebuyers are tripping up in the mortgage process.

Here are seven reasons your mortgage application could be denied:

You recently opened a new credit card or personal loan

Taking on new debts prior to beginning the mortgage application process is a “big no-no,” says Denver, Colo.-based loan officer Jason Kauffman. That includes every type of debt — from credit cards and personal loans to buying a car or financing furniture for your new digs.

That’s because lenders will have to factor any new debt into your debt-to-income ratio.

Your debt-to-income ratio is fairly simple to calculate: Add up all your monthly debt payments and divide that number by your monthly gross income.

A good rule of thumb is to avoid opening or applying for any new debts during the six months prior to applying for your mortgage loan, according to Larry Bettag, attorney and vice president of Cherry Creek Mortgage in Saint Charles, Ill.

For a conventional mortgage loan, lenders like to see a debt-to-income ratio below 40%. And if you’re toeing the line of 40% already, any new debts can easily nudge you over.

Rick Herrick, a loan officer at Bedford, N.H.-based Loan Originator told MagnifyMoney about a time a client opened up a Best Buy credit card in order to save 10% on his purchase just before closing on a new home. Before they were able to close his loan, they had to get a statement from Best Buy showing what his payments would be, and the store refused to do so until the first billing cycle was complete.

“Just avoid it all by not opening a new line of credit. If you do, your second call needs to be to your loan officer,” says Herrick. “Talk to your loan officer if you’re having your credit pulled for any reason whatsoever.”

Your job status has changed

Most lenders prefer to see two consistent years of employment, according to Kauffman. So if you recently lost your job or started a new job for any reason during the loan process, it could hurt your chances of approval.

Changing employment during the process can be a deal killer, but Herrick says it may not be as big a deal if there is very high demand for your job in the area and you are highly likely to keep your new job or get a new one quickly. For example, if you’re an educator buying a home in an area with a shortage of educators or a brain surgeon buying a home just about anywhere, you should be OK if you’re just starting a new job.

If you have a less-portable profession and get a new job, you may need to have your new employer verify your employment with an offer letter and submit pay stubs to requalify for approval. Even then, some employers may not agree to or be able to verify your employment. Furthermore, if your salary includes bonuses, many employers won’t guarantee them.

Bettag says one of his clients found out he lost his job the day before they were due to close, when Bettag called his employer for one last check of his employment status. “He was in tears. He found out at 10 a.m. Friday, and we were supposed to close on Saturday.”

You’ve been missing debt payments

During the loan process, any recent negative activity on your credit report, which goes back seven years, can raise concerns. The real danger zone is any activity reported within the last two years, says Bettag, which is the time period lenders play closest attention to.

That’s why he encourages loan applicants to make sure their credit reports are accurate and that old items that should have fallen off your report after seven years aren’t still appearing.

“Many things show on credit reports beyond seven years. That’s a huge issue, so we want to get dated items removed at the bureau level,” Bettag says.

For first-time homebuyers, he cautions against making any late payments six months prior to applying for a mortgage. They won’t always be a total deal-breaker, but they can obviously ding your credit, and a lower credit score can lead to a loan denial or a more expensive mortgage rate.

Existing homeowners, Bettag says, shouldn’t have any late mortgage payments in the 12 months prior to applying for a new mortgage or a refinance.

“There are workarounds, but it can be as laborious as brain surgery,” says Bettag.

You accepted a monetary gift

Your lender will be on the lookout for any out-of-place deposits to your bank accounts during the approval process. Bettag advises homebuyers not to accept any large monetary gifts at least two months or longer before you apply, and to keep a paper trail if the lender has any questions.

Any cash that can’t be traced back to a verifiable source, such as an annual bonus, or a gift from a family friend, could raise red flags.

This can be tricky for homebuyers who are relying on help from family to purchase their home. If you receive a gift of money for a down payment, it has to be deemed “acceptable” by your lender. The definition of acceptable depends on the type of mortgage loan that you are applying for and the laws that govern the process in your state.

For example, Bettag says, the Federal Housing Authority doesn’t care if a borrower’s entire down payment comes as a gift when they are applying for an FHA loan. However, the gifted funds may not be eligible to use as a down payment for a conventional loan through a bank.

You moved a large amount of money around

Ideally, avoid moving large sums of money about two months before applying.

Herrick says many borrowers make the mistake of shuffling too much cash around just before co-signing, making themselves look suspicious to bank regulators. Herrick says not to move anything more than $1,000 at a time, and none if you can help yourself.

For example, If you’re considering moving money from all of your savings accounts into one account to deliver the cashier’s check for the down payment, don’t do it. You don’t need to have everything in one account for the cashier’s check for your closing. You can submit multiple cashier’s checks. All the lender cares about is that all of the money adds up. You may be able to simply avoid some of this hassle by arranging to pay using a wire transfer. Just be sure to schedule it in time.

You overdrafted your checking account

If you have a credit issue already, says Bettag, overdrafting your checking account can be a deal-breaker, but it won’t cause as much of an issue if you have great credit and offer a good down payment. Still avoid overdrafting for at least two months prior to applying for the mortgage loan.

You may be the type to keep a low checking account balance in favor of saving more money. But if an unexpected bill could risk overdrafting your account, try keeping a few extra dollars in the account for padding, just in case.

You forgot to include debts or other information on your loan application

Your loan officer should carefully review your application to make sure it’s filled out completely and accurately. Missing a zero on your income, or accidentally skipping a section, for example, could mean rejection. A small mistake could mean losing your dream home.

There’s also the chance you accidentally omitted information the underwriter caught in the more extensive screening process, like money owed to the IRS. Disclose all of your debt to your loan officer up front. Otherwise, they may not be able to help you if the debt comes up and disqualifies you for your dream home later on.

If you owe the IRS money and are in a payment plan, Bettag says your loan officer can still work with you. However, they want to see that you’ve been in a plan for at least three months and made on-time payments to move forward.

“Can you imagine not paying your IRS debt, getting into a payment plan, and then not paying on the agreed plan? Not cool for lenders to see, but we do,” says Bettag.

The Bottom Line

There is no hard and fast rule on how long before you begin the mortgage process that you should heed these warnings. It all varies, according to Bettag. If you have excellent credit and a strong income, you might be able to get away with a recently opened credit card or other discrepancies — minor faults that might totally derail the application of a person who has bad credit and inconsistent income.

Whatever the case may be, Bettag encourages prospective homebuyers to stick to one general rule: “Don’t do anything until you’ve consulted with your loan officer.”

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Mortgage

Buying a House When You Have Student Loan Debt

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Buying a House When You Have Student Loan Debt

Student loan debt is a reality for many people wishing to buy homes. Fortunately, it does not have to be a deal-breaker. But there’s no getting around the fact that a large amount of student loan debt will certainly influence how much financing a lender will be willing to offer you.

In the past, mortgage lenders were able to give people with student loans a bit of a break by disregarding the monthly payment from a student loan if that loan was to be deferred for at least one year after closing on the home purchase. But that all changed in 2015 when the Federal Housing Authority, Fannie Mae, and Freddie Mac began requiring lenders to factor student debt payments into the equation, regardless of whether the loans were in forbearance or deferment. Today by law, mortgage lenders across the country must consider a prospective homebuyer’s student loan obligations when calculating their ability to repay their mortgage.

The reason for the regulation change is simple: with a $1.3 million student loan crisis on our hands, there is concern homebuyers with student loans will have trouble making either their mortgage payments, student loan payments, or both once the student loans become due.

So, how are student loans factored into a homebuyer’s mortgage application?

Anytime you apply for a mortgage loan, the lender must calculate your all-important debt-to-income ratio. This is the ratio of your total monthly debt payments versus your total monthly income.

In most cases, mortgage lenders now must include 1% of your total student loan balance reflected on the applicant’s credit report as part of your monthly debt obligation.

Here is an example:

Let’s say you have outstanding student loans totaling $40,000.

The lender will take 1% of that total to calculate your estimated monthly student loan payment. In this case, that number would be $400.

That $400 loan payment has to be included as part of the mortgage applicant’s monthly debt expenses, even if the loan is deferred or in forbearance.

Are Student Loans a Mortgage Deal Breaker? Not Always.

If you are applying for a “conventional” mortgage, you must meet the lending standards published by Fannie Mae or Freddie Mac. What Fannie and Freddie say goes because these are the two government-backed companies that make it possible for thousands of banks and mortgage lenders to offer home financing.

In order for these banks and mortgage lenders to get their hands on Fannie and Freddie funding for their mortgage loans, they have to adhere to Fannie and Freddie’s rules when it comes to vetting mortgage loan applicants. And that means making sure borrowers have a reasonable ability to repay the loans that they are offered.

To find out how much borrowers can afford, Fannie and Freddie require that a borrower’s monthly housing expenses (that includes the new mortgage, property taxes, and any applicable mortgage insurance) to be no more than 43% of their gross monthly income.

On top of that, they will also look at other debt reported on your credit report, such as credit cards, car loans, and, yes, those student loans. You cannot go over 49% of your gross income once you factor in all of your monthly debt obligations.

For example, if you earn $5,000 per month, your monthly housing expense cannot go above $2,150 per month (that’s 43% of $5,000). And your total monthly expenses can’t go above $2,450/month (that’s 49% of $5,000). Let’s put together a hypothetical scenario:

Monthly gross income = $5,000/month

Estimated housing expenses: $2,150
Monthly student loan payment: $400
Monthly credit card payments: $200
Monthly car payment: $200

Total monthly housing expenses = $2,150

$2,150/$5,000 = 43%

Total monthly housing expenses AND debt payments = $2,950

$2,950/$5,000 = 59%

So what do you think? Does this applicant appear to qualify for that mortgage?

At first glance, yes! The housing expense is at or below the 43% limit, right?

However, once you factor in the rest of this person’s debt obligations, it jumps to 59% of the income — way above the threshold. And these other monthly obligations are not beyond the norm of a typical household.

What Can I Do to Qualify for a Mortgage Loan If I Have Student Debt?

So what can this person do to qualify? If they want to get that $325,000 mortgage, the key will be lowering their monthly debt obligations by at least $500. That would put them under the 49% debt-to-income threshold they would need to qualify. But that’s easier said than done.

Option 1: You can purchase a lower priced home.

This borrower could simply take the loan they can qualify for and find a home in their price range. In some higher priced real estate markets it may be simply impossible to find a home in a lower price range. To see how much mortgage you could qualify for, try out MagnifyMoney’s home affordability calculator.

Option 2: Try to refinance your student loans to get a lower monthly payment.

Let’s say you have a federal student loan in which the balance is $30,000 at a rate of 7.5% assuming a 10-year payback. The total monthly payment would be $356 per month. What if you refinanced the same student loan, dropped the rate to 6%, and extended the term to 20 years? The new monthly payment would drop to $214.93 per month. That’s a $142 dollar per month savings.

You could potentially look at student loan refinance options that would allow you to reduce your loan rate or extend the repayment period. If you have a credit score over 740, the savings can be even higher because you may qualify for a lower rate refi loan. Companies like SoFi, Purefy, and LendKey offer the best rates for student loans, and MagnifyMoney has a full list of great student loan refi companies.

There are, of course, pros and cons when it comes to refinancing student loans. If you have federal loan debt and you refinance with a private lender, you’re losing all the federal repayment protections that come with federal student loans. On the other hand, your options to refinance to a lower rate by consolidating federal loans aren’t that great. Student debt consolidation loan rates are rarely much better, as they are simply an average of your existing loan rates.

Option 3: Move aggressively to eliminate your credit card and auto loan debt.

To pay down credit debt, consider a balance transfer. Many credit card issuers offer 0% introductory balance transfers. This means they will charge you 0% interest for an advertised period of time (up to 18 months) on any balances you transfer from other credit cards. That buys you additional time to pay down your principal debt without interest accumulating the whole time and dragging you down.

Apply for one or two of these credit cards simultaneously. If approved for a balance transfer, transfer the balance of your highest rate card immediately. Then commit to paying it off. Make the minimum payments on the other cards in the meantime. Focus on paying off one credit card at a time. You will pay a fee of 3% in some cases on the total balance of the transfer. But the cost can be well worth it if the strategy is executed properly.

Third, if the car note is a finance and not a lease, there’s a mortgage lending “loophole” you can take advantage of. A mortgage lender is allowed to omit any installment loan that has less than 10 payments remaining. A car is an installment loan. So if your car loan has less than 10 payments left, the mortgage lender will remove these from your monthly obligations. In our hypothetical case above, that will give this applicant an additional $200 per month of purchasing power. Maybe you can reallocate the funds from the down payment and put it toward reducing the car note.

If the car is a lease, you can ask mom or dad to refinance the lease out of your name.

Option 4: Ask your parents to co-sign on your mortgage loan.

Some might not like this idea, but you can ask mom or dad to co-sign for you on the purchase of the house. But there are a few things you want to make sure of before moving forward with this scenario.

For one, do your parents intend to purchase their own home in the near future? If so, make sure you speak with a mortgage lender prior to moving forward with this idea to make sure they would still qualify for both home purchases. Another detail to keep in mind is that the only way to get your parents off the loan would be to refinance that mortgage. There will be costs associated with the refinance of a few thousand dollars, so budget accordingly.

With one or a combination of these theories there is no doubt you will be able to reduce the monthly expenses to be able to qualify for a mortgage and buy a home.

The best piece of advice when planning to buy a home is to start preparing for the process at least a year ahead of time. Fail to plan, plan to fail. Don’t be afraid to allow a mortgage lender to run your credit and do a thorough mortgage analysis.

The only way a mortgage lender can give you factual advice on what you need to do to qualify is to run your credit. Most applicants don’t want their credit run because they fear the inquiry will make their credit score drop. In many cases, the score does not drop at all. In fact, credit inquiries account for only 10% of your overall credit score.

In the unlikely event your credit score drops a few points, it’s a worthy exchange. You have a year to make those points go up. You also have a year to make the adjustments necessary to make your purchase process a smooth one. Do keep in mind that it is best to shop for mortgage lenders and perform credit inquiries within a week of each other.

You should also compare rates on the same day if at all possible. Mortgage rates are driven by the 10-year treasury note traded on Wall Street. It goes up and down with the markets, and we’ve all seen some pretty dramatic swings in the markets from time to time. The only way to make an “apples-to-apples” comparison is to compare rates from each lender on the same day. Always request an itemization of the fees to go along with the rate quote.

Rafael Reyes
Rafael Reyes |

Rafael Reyes is a writer at MagnifyMoney. You can email Rafael here

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Mortgage

Guide to Getting the Best Rate on Your Mortgage

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Guide to Getting the Best Rate on Your Mortgage

A house is the single largest asset that most Americans will ever buy. The median price of a home sold in the United States is up to $301,300, and the median household income of a homeowner is $60,000. This means that a house now costs more than five times the income of a typical homebuyer.

With prices so high, it’s more important than ever to find a great rate on your mortgage. Finding the lowest rate can save you tens of thousands of dollars over the lifetime of a loan. But finding the best rates on the loans with the right features can be a challenge. In this guide we’ll teach you how to find the best mortgage rates.

Finding the best rate on a mortgage

When it comes to buying a house, you don’t just need to house hunt; you need to shop for a mortgage. According to the Consumer Financial Protection Bureau (CFPB), just 53% of Americans shop for mortgages, but comparing lenders has a huge payoff. Saving 1% on your rate will save you tens of thousands of dollars over the life of your loan. Your mortgage can make or break the affordability of a house, and it’s up to you to find the best rates. These are the steps you can take to find the best rates.

Compare rates using the CFPB’s handy tool

The CFPB offers a tool that allows you to compare the prevailing interest rates on various types of loans. To use the tool, you need to know your credit score, the amount you intend to borrow, and how much money you have for a down payment.

By exploring the different options, you can determine the best rates in your state, and the most common rates.

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This tool will give you an idea of the rate landscape in your state. However, you still need to do work to get the best rates.

Next, find lenders that offer the lowest rates

Once you know the lowest interest rates, you can find the lenders offering those rates through search engine queries. Enter the following formula: “State Mortgage, X% Interest Rate, Loan Type.”

For example, “Alabama Mortgage, 3.75% Interest Rate, 30-Year Fixed Rate.”

The bank or credit union with the best rate should emerge near the top of the search rankings. You will find mortgage comparison websites that will help you connect with the banks. Mortgage comparison websites can be a helpful resource, but they require your contact information. If you use a comparison site, expect to receive phone calls or email solicitations.

Continue to cross-reference the rates from comparison sites with information from the CFPB. The rates on a mortgage comparison site should be as good as those on the CFPB’s site.

If a lender has already pre-approved you, they may be willing to match the lowest rate. Talk with your loan officer about the rate you saw on the CFPB’s website. Ask them to match the rate. If they will, the conversation saves you time and money.

Get pre-approved for a mortgage from multiple banks

Once you find the banks with the best rates, consider getting pre-approved for mortgage rates from a few different banks. A pre-approval means that a bank plans to give you a loan at a given rate. You will need to submit documentation to a loan officer to get pre-approved. Typical documentation includes W-2 forms, tax returns, credit reports, and evidence of assets.

The bank will review your documentation and give you a pre-approval letter. The letter explains how much you can borrow and at what rate. If you’re denied at this stage, you can find out why.

A pre-approval is not a contract. It is not subject to underwriting or an appraisal. Rates can change after you get a pre-approval. That’s why we recommend getting multiple pre-approvals if you can.

When you’re pre-approved, a bank will give you a letter that you can submit with offers on a home. Home sellers want to see a pre-approval letter because it means that you’re likely to have access to the financing to close a deal.

Once you have pre-approvals in hand, start shopping for houses. You can submit a bid and negotiate a price using your pre-approvals.

Request loan estimates from lenders

Once a seller accepts your bid, request loan estimates from all the banks that pre-approved you.

A loan estimate is a three-page document that contains an estimated interest rate, monthly payments, and closing costs for the specific loan. It explains everything you need to know about the loan if you choose to move forward.

Compare all the loan estimates before committing to a particular mortgage lender. Loan estimates allow you a true apples-to-apples comparison of interest rates.

A loan estimate isn’t a contract. The bank may deny the loan based on the home’s appraisal values or due to underwriting problems. But a loan estimate will allow you to make an informed decision.

Factors that influence your interest rate

Shopping for a mortgage isn’t the only way to find the best interest rate. You can influence the rate by controlling these factors.

Credit score

The better your credit history, the better your rate will be. In some cases, the difference can be a full percentage point or more. Fixing your credit score is one of the best ways to influence your mortgage rate. Depending on your credit history, you might be able to fix your credit score on your own within a few months.

When you’re shopping for a mortgage, pay your bills on time and keep your credit usage low. Try to use 10% or less of your total available credit. Don’t close old credit accounts or apply for new accounts when mortgage shopping. These actions promote a high credit score while you shop for a mortgage.

Down payment & PMI

In general a bigger down payment means a lower interest rate.

If you put down at least 5%, you will probably qualify for the lowest advertised rates. But don’t confuse the lowest interest rates with the lowest cost financing. Most banks require you to purchase private mortgage insurance (PMI) if you don’t put at least 20% down on a home. PMI adds about .5%-1% per month on your mortgage. You won’t be able to remove PMI until you’ve built up at least 20% equity in your home. You build equity when your home rises in value and when you pay down your mortgage.

If you have a down payment less than 5%, you’ll need to look at FHA loans or VA loans. VA loans don’t require PMI, but you will have to pay an upfront financing fee. This is a fee that doesn’t help you build equity, but VA loans have competitive rates for people who don’t have a down payment. Check the fee schedule for VA loans to see if the financing fee is worth it to you.

FHA loans require just a 3.5% down payment, but FHA loans have require mortgage insurance premiums (MIP). The MIP is an upfront fee (usually 1.75% of the total mortgage) and monthly interest rate hike of around .5%. You can’t get rid of MIP unless you get rid of your FHA loan.

Location

Buyers looking for a mortgage in a rural area may see higher rates compared to equally qualified buyers in nearby urban areas. Most lenders have less familiarity with lending in rural areas. This leads to higher rates. In rural settings, you may get the best rates from nearby banks and credit unions.

Rates also differ on a state-by-state basis. States that have laws that make foreclosure difficult tend to have higher mortgage rates than states with looser foreclosure laws. Likewise, states that require lenders to have a physical presence in the state raises interest rates.

Loan size

Interest rates on small mortgages (less than $50,000) tend to be higher than rates on typical mortgage sizes. Small mortgages are less profitable than other loans, and many banks won’t issue this size mortgage. Borrowers may need to work with local banks or credit unions or government lending programs to find a micro-mortgage.

At the other end of the spectrum, jumbo mortgages tend to track closely to conforming loan interest rates. Banks can’t sell jumbo loans in the secondary market, so they are riskier for the bank compared to other mortgages. Usually, banks compensate higher risk with higher interest rates. However, the rigorous underwriting on jumbo loans may drive many poor prospects out of the market.

Length of loan (Loan term)

Mortgages with shorter terms have lower rates than those with longer terms. A longer term represents more risk for the bank. Banks compensate their risk with higher interest rates. This doesn’t mean that a shorter term loan is always the right choice. Choose the loan term that fits your needs before you compare rates. That way you’ll get the best interest rate on the right mortgage for you.

Fixed or variable rates

Adjustable-rate mortgages put more risk onto borrowers. You’ll initially pay a lower interest rate if you take out an adjustable-rate mortgage, but the rate might increase.

When you’re considering an adjustable-rate, learn when and how the interest rate adjusts. Most loans adjust based on a set index. In a low interest rate environment, you can expect rates to increase, but you need to guess how much. Weigh whether the low rates now are worth a potential high rate in the future.

Conforming vs. FHA vs. VA vs. conventional

The company that backs your loan may seem unimportant, but it influences your rate.

Conforming loans (those that can be purchased by Fannie Mae or Freddie Mac, the largest purchasers of mortgage loans in the U.S.) tend to have the lowest interest rates. Despite their low interest rates, conforming loans are profitable for banks. Banks can easily sell conforming loans to Fannie Mae or Freddie Mac and reinvest the proceeds in making more loans. Conforming loans require at least a 5% down payment and good credit. For conforming loans, put 20% down to avoid paying PMI.

FHA loans have more lenient down payment and credit standards. They tend to be expensive for well-qualified buyers. However, an FHA loan may be the right option if you have a low down payment or a poor credit score. Only you can determine if the extra cost is worth it for you. VA loans are available to veterans, and they charge an upfront fee. However, they offer competitive rates for first-time homebuyers. If you can qualify for a VA loan, look into it as an option.

Conventional loans can’t be purchased by Fannie Mae or Freddie Mac. They require more shopping around to find the best rates. Not every lender issues conventional loans. If you qualify, the rates should be competitive with rates on conforming loans.

If you’re taking out a jumbo mortgage, you need to qualify for conventional underwriting. Likewise, condo buyers may need to qualify for a conventional loan. Fannie Mae and Freddie Mac will not purchase a mortgage if the property is part of an association that has more than 50% renter occupants.

Buying points

Many lenders offer to let borrowers buy “discount points” off of a mortgage. This means that you pay a set fee in exchange for the lender to lower your rate. In some circumstances buying discount points makes sense. Divide the cost of the point by the change in your monthly payment. This will tell you the number of months it takes for the prepayment to pay off (in terms of savings). If you expect to stay in the house significantly longer than the payoff period, go ahead and purchase the points. Otherwise, pay the higher interest.

Closing costs

An advertised interest rate doesn’t account for your total cost to borrow money. Most banks make their real money by charging closing fees. Banks might charge loan origination fees, recording fees, title inspection fees, underwriting fees, and application fees.

All the financing charges will be disclosed on a loan estimate. The loan estimate will also provide you with an annual percentage rate (APR), which expresses the total cost of borrowing money including the financing fees.

Special programs

Cities and states often issue special interest rates on loans for homebuyers who meet certain criteria. For example, Raleigh, N.C., subsidizes a $20,000 down payment loan for low-income, first-time homebuyers in distressed neighborhoods. Check your city, county, and state websites to see if you qualify for special rate programs. These programs often have favorable borrowing terms in addition to great rates.

Accelerating payments

Some borrowers cut their total interest costs by accelerating their mortgage payoff. If you make a half mortgage payment every two weeks, you’ll make an extra mortgage payment every year. This cuts a 30-year mortgage down to 23 years.

Making extra payments early in the life of your loan will help you achieve 20% equity faster. This will allow you to drop PMI payments or refinance at a lower rate.

Determining a budget for your loan

Finding a great rate on a loan that you can’t pay back is a sure way to destroy your credit. Before you apply for a loan, establish a realistic budget for your monthly mortgage payment. Avoid borrowing more than you can comfortably pay back.

When banks approve you for a mortgage, they will lend based on your current debt-to-income ratio without considering your other costs of living. Lenders have some limits, but you need to establish your own limits. Most of the time, lenders will not extend mortgage loans to borrowers whose monthly debt liabilities eat up more than 43% of their gross monthly income.

To understand debt-to-income ratio, consider this example. A person with a $60,000 annual income and a $500 monthly car payment applies for a mortgage.

A bank will allow them to carry a debt load up to $2,150 per month (($60,000/12)*43%). The bank subtracts the $500 from the maximum allowed debt load and determines that this person can afford $1,650 in house payments each month.

The bank in this example determines that $1,650 a month is an affordable budget.

No matter how large a loan you can get, you need to be a savvy consumer. The Consumer Financial Protection Bureau recommends that your entire housing payment (including taxes, insurance, and association dues) should take up no more than 28% of your gross income.

The CFPB’s advice may seem too strict, but you need to determine your non-mortgage-related cost of living before committing to a new loan. Calculate costs like income taxes, transit expenses, and child care or education costs. If you pay alimony or for out-of-pocket health care, consider those costs too. Plus, you’ll need to factor in the costs of home maintenance. Experts recommend setting aside 1%-3% of your home’s purchase price for maintenance and upgrades.

A 43% debt-to-income ratio may be manageable for people who expect a significant salary bump in the near future. But for many, such a high ratio could get you into credit trouble.

If you’re seriously shopping for houses, use Zillow’s advanced affordability calculator to determine how much mortgage makes sense for you. You can also learn if buying makes financial sense by using the Rent vs. Buy Calculator from realtor.com.

Before you start shopping for houses, determine how a mortgage will fit into your budget. Don’t succumb to pressures to overextend your budget. A burdensome mortgage has the power to turn a dream house into a nightmare. You can avoid the nightmare by planning ahead.

Determining loan features you want

In addition to establishing a budget, you need to understand how to find the right features on a mortgage. A great rate on a bad mortgage could spell financial ruin. When you’re shopping for loans, ask yourself these questions:

How long will you stay in the home?

Some buyers purchase houses with the intention of staying just a few years. Someone who plans to sell in a few years might consider a lower interest rate adjustable mortgage. However, an adjustable-rate mortgage is risky for someone who intends to live in a home long term.

How risky is your financial situation?

Do you and your partner have two steady jobs and a large cash cushion? In such a stable situation, you might feel comfortable putting 20% down. You might also feel good locking into a 15-year mortgage to save on interest.

People with less stable income and finances might feel more comfortable with a smaller down payment and a longer payoff period. This will mean paying PMI and higher financing costs, but they can be worth it for peace of mind.

Do you expect to have better cash flow in the future?

If you think that you’ll have more accessible cash flow in the future, you can borrow near the higher end of your limits today. An interest-only loan will allow you to get into a house with lower payments now and higher payments in the future. Of course, you need to be realistic about your future expectations. Your future income may be more modest than you hope, or you may face high costs in the future. An interest-only loan could leave you trapped in a house if housing prices decline.

Even if you expect a higher income, borrowing near the top end of your budget could keep you “house poor.” If the raise doesn’t pan out, you’ll be stuck in a house that you can’t comfortably afford.

Do you have access to other sources of financing?

Alternative sources of financing like a home equity line of credit make a loan with a balloon payment more viable. Alternative financing means that you’ll have options if your original mortgage payoff plan falls through.

Anyone considering a balloon payment loan should have a solid lead on alternative financing before they take out the loan.

How much cash do you have for a down payment?

You can purchase a house with almost no money down. For example, the Federal Housing Association (FHA) offers “$100 Down” home financing on select HUD homes, or down payments as low as 3.5% for FHA-backed loans. Veterans can purchase homes using $0 down VA loans.

On the other hand, if you have more money to put down, you may qualify for a conventional mortgage or a mortgage backed by Fannie Mae or Freddie Mac. The more cash you have, the more options you have for loan types.

Do you have compelling uses for cash outside of a home down payment?

Putting a large amount of money down on your home locks up the cash. You can access home equity through a home equity line of credit, but that introduces a new element of risk. Even if you have a large amount of cash, you may not want to use it to fund a down payment. For example, you may want to hold cash for an emergency fund, to start a business, or to fund some other purchase.

If you have a compelling reason to hold onto cash, you may intentionally narrow your mortgage search to low down-payment options.

How quickly do you want to pay off your house?

A paid-off home might be your top financial priority. In that case, you might want to look for options with a short payoff period. For example, you might prioritize the forced savings of a 15-year mortgage. You might even aim to payoff a 5/1 ARM before the first rate adjustment if you have sufficient cash.

How important is the monthly payment?

A lot of people prioritize a low monthly payment above any other factor. You can achieve a low payment by avoiding fees (like PMI), finding the lowest possible interest rate, and extending the terms of the loan. Even more important than those factors is borrowing an amount that you can easily afford under most circumstances.

Common mortgage terms

Sometimes the most difficult part about shopping for a mortgage is understanding the terms that lenders use. Below we’ve defined a few of the most common mortgage terms that you should know before you sign a loan.

  • Interest Rate – The amount charged by a lender for a borrower to use the loaned money. This is expressed as a percentage of the total loan amount.
  • APR – The annual percentage rate is the total amount that it costs to borrow money from a lender expressed as a percentage. The APR factors in closing costs and other financing fees.
  • Amortization Schedule – A table that shows how much of each payment goes to the principal loan balance versus the interest portion of the loan.
  • Term – A set period of time over which a fixed loan payment will be due (often 15 or 30 years).
  • Fixed-Rate Mortgage – A mortgage where the interest rate stays the same for the entire term of the loan.
  • Adjustable-Rate Mortgage – A mortgage where the interest rate changes based on factors outlined in the loan agreement. Often, the adjustment is tied to a certain publicly available interest rate like the Federal Exchange Rate. Adjustable-rate mortgages are considered riskier than fixed-rate mortgages due to the potential volatility of payments. Adjustable-rate mortgages (ARMS) include:
    • 1-Year ARM – A mortgage where the interest rate adjusts up to once per year for the life of a loan.
    • 10/1 ARM – A mortgage where the interest rate is fixed for ten years and then increases up to once per year for the remaining life of the loan.
    • 5/1 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every year for the life of the loan.
    • 5/5 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every five years for the life of the loan.
    • 5/25 ARM – Also known as the five-year balloon mortgage. A 5/25 loan is a subprime loan with a fixed rate for the first five years of the loan. If a borrower meets certain standards (usually a record of on-time payments), they will receive the right to refinance the remaining 25 years on an adjustable-rate mortgage. Otherwise, the bank requires a “balloon” or remaining balance payment after five years.
    • 3/1 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once per year for the life of the loan.
    • 3/3 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once every three years for the life of the loan.
    • Two-Step Mortgage – A mortgage that offers a fixed interest rate for a fixed period of time (usually 5 or 7 years). After the fixed period, the rate adjusts to current market rates. Often, the borrower can choose either a fixed rate or an adjustable rate during the second step.
  • Interest-Only Mortgage – A mortgage where a borrower pays only the interest on a loan for a fixed period (usually 5-7 years).
  • PMI – Private mortgage insurance is a product that protects a bank if you default on your mortgage. Lenders often require borrowers with less than 20% equity to purchase PMI.
  • Jumbo Mortgage – A mortgage that is larger than the standards for a “conforming loan” set by government-backed agencies. In most parts of the U.S. a jumbo loan must be larger than $417,000. In some of the highest cost of living areas, a jumbo is in excess of $625,000.
  • Fannie Mae – The Federal National Mortgage Association is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Freddie Mac – The Federal Home Loan Mortgage Corporation is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Conforming Loan – A mortgage that meets the funding criteria of Fannie Mae and Freddie Mac. The most stringent criteria is the loan size.
  • FHA Loan – A loan guaranteed by the Federal Housing Administration. Qualifying standards are not as stringent, but the fees are higher. In addition to a monthly premium (similar to PMI), borrowers pay a “borrowing” premium when they take out the loan.
  • VA Loan – A mortgage guaranteed by the Department of Veterans Affairs. Veterans can purchase houses with a $0 down payment when using a VA loan, provided the veteran meets other lending criteria.
  • Conventional Mortgage – A mortgage that is not guaranteed by any of the federal funding agencies. Certain homes or condominiums will only qualify for a conventional mortgage financing option.
  • Down Payment – The initial payment that a homebuyer supplies when purchasing a home with a mortgage.
  • Balloon Mortgage – A mortgage where a borrower pays fixed payments for a period of time (usually 5 or 7 years) after which the balance of the loan is due. This is considered a high-risk loan.
Hannah Rounds
Hannah Rounds |

Hannah Rounds is a writer at MagnifyMoney. You can email Hannah at hannah@magnifymoney.com

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Guide to Getting a Federal Housing Administration (FHA) Mortgage Loan

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Couple Celebrating Moving Into New Home With Champagne

Saving up the traditional 20% for a mortgage down payment is the kind of financial obstacle that can bar first-time homebuyers with minimal savings from becoming homeowners. The government-backed Federal Housing Administration (FHA) mortgage is one solution for those who want to buy a home but can’t pull together a large down payment.

FHA mortgages are home loans funded by FHA-approved lenders and insured by the government.

The government backing protects lenders from loss if borrowers default. Because of this protection, lenders can be more lenient with their qualifying criteria and can accept a significantly lower down payment.

You can get approved for an FHA mortgage with a minimum credit score of 500, and you only need to put 3.5% to 10% down to buy a home.

How much can an FHA mortgage help you?

For a $150,000 home, a 20% down payment would mean you would need to bring $30,000 (along with other closing costs) to the table. That’s no small chunk of change. By comparison, an FHA mortgage would require anywhere from 3.5% to 10% for a down payment, which comes out to $5,250 to $15,000.

In this post, we’ll cover the following topics to explain the FHA mortgage, including:

  • FHA mortgage terms
  • FHA qualifying criteria and restrictions
  • FHA costs and mortgage premiums
  • FHA mortgages vs. conventional mortgages
  • How to shop for an FHA mortgage

FHA mortgage terms

There are both 15- and 30-year fixed-rate and adjustable-rate FHA mortgage options. With a fixed-rate FHA mortgage, your interest rate is consistent through the loan term. However, your monthly mortgage payment may increase based on your homeowners insurance, mortgage insurance premium, and property taxes.

Adjustable-rate FHA mortgages are home loans where the rate stays low and fixed during an introductory period of time such as five years. Once the introductory period ends, the interest rate will adjust, which means your monthly mortgage payments may increase.

A unique situation where signing up for a low, adjustable-rate FHA mortgage could make sense is if you plan to sell or refinance the home before the introductory period ends and the interest rate can change. Otherwise, a fixed-rate FHA mortgage has predictable mortgage payments and may be the way to go.

Qualifying criteria and restrictions

Although the FHA home loan is particularly appealing for first-time homebuyers, it’s not only open to first-time purchasers. Repeat buyers planning to use the home as a primary residence may qualify for an FHA home loan as well.

Besides the low down payment, an undeniable benefit of the FHA mortgage is the low credit score requirement. You may qualify for 3.5% down payment with a credit score of 580 or higher. You can also qualify with a credit score lower than 580, but you’ll have to make a 10% down payment.

Debt-to-income (DTI) ratio is another key metric lenders consider in addition to your credit score to determine whether you can afford a mortgage. DTI measures the amount of debt you have compared to your income, and it’s expressed in a percentage.

Lenders look at two debt-to-income ratios when determining your eligibility — housing ratio or front-end ratio and your total debt ratio or back-end ratio.

Your front-end ratio is what percentage of your income it would take to cover your total monthly mortgage payment. Lenders like to see your front-end ratio below 31% of your gross income.

Your back-end ratio shows how much of your income is needed to pay for your total monthly debts. Lenders prefer a back-end ratio of 43% or less of your gross income.

FHA limits

The FHA mortgage can be used for both single-family and multi-family homes, but there are loan amount maximums that vary by state and county.

For an example, in Fulton County, Atlanta, the maximum loan for a single-family house is $342,700. You can find the loan limits for all states and counties here.

 

FHA mortgage costs and mortgage insurance premium

Just like a traditional mortgage, an FHA home loan has closing costs. Closing costs are the costs necessary to complete your transaction, such as appraisals and home inspections. However, you may be able to negotiate to have some of these costs covered by the seller.

The real expense of the FHA home loan lies in the mortgage insurance premiums.

At first glance, the FHA mortgage probably seems like the ultimate hack to buying a home with minimal savings. The flip side to this is you need to pay mortgage insurance premiums to cover the lender for the lower down payment.

Remember, FHA-approved lenders offer mortgages that require less money down and flexible qualifying criteria because the Federal Housing Administration will cover the loss if you default on the loan. The government doesn’t do this for free.

FHA mortgage borrowers must “put money in the pot” to cover the cost of this backing through upfront and annual mortgage insurance premiums. The upfront insurance premium for the FHA mortgage is currently 1.75% of the loan amount, and it can be rolled into your mortgage balance.

The annual insurance premium is broken into a payment that you make monthly. The annual premium for mortgage insurance can be up to 1.05% based on your loan term length, loan amount, and loan-to-value ratio (LTV).

LTV is a percentage that compares your loan amount to your home’s value. It also represents the equity (or lack of equity) you have in the property.

For example, putting 3.5% down means your LTV would be 96.5%. In other words, you have 3.5% equity in the home, and your loan is covering the remaining 96.5% of the home value.

Here’s the annual mortgage insurance premium on a 30-year FHA mortgage (for loans less than $625,000):

  • LTV over 95% (you initially have less than 5% equity in the home) – 0.85%
  • LTV under 95% (you initially have more than 5% equity in the home) – 0.8%

As you can see, starting off with less equity (or a smaller down payment) will cost you more in insurance premiums. You can expect to pay 0.85% in annual mortgage insurance premiums if your down payment is 3.5% on the 30-year mortgage.

Unfortunately, if your LTV was greater than 90% at time of origination, insurance premiums tag along for the entire loan term or 11 years, whichever comes first. There are exceptions if you have an FHA mortgage that was taken out before June 3, 2013.

How does the FHA home loan compare to conventional home loans?

Government-backed home loans like the FHA mortgage are part of special programs that serve borrowers that can’t qualify for a traditional mortgage.

At the other end of the spectrum is the conventional mortgage or the “Average Joe” of mortgages.

These traditional mortgages are offered by lenders and banks backed by Fannie Mae and Freddie Mac’s mortgage standards. Fannie Mae and Freddie Mac are government-sponsored agencies that buy loans from mortgage lenders and banks that conform to preset requirements.

Since conventional mortgages are loans eligible to be purchased by Fannie Mae and Freddie Mac, the qualifying criteria bar is usually set higher. For instance, you should have at least a 620 credit score to qualify for a fixed-rate conventional loan. Although, credit score minimums vary by lender, and a score above 620 will be necessary for the most competitive interest rates.

A misconception about the conventional mortgage is that borrowers must have 20% for a down payment to qualify. Mortgage lenders may accept less than 20% down for a conventional mortgage if you have a high credit score and pay their version of mortgage insurance premiums, which is called private mortgage insurance (PMI).

PMI is a private insurance policy that protects the lender if you default. Be careful not to confuse the two types of insurance policies.

If you have PMI on a conventional mortgage, you’re able to request a removal of insurance payments when you build up 20% equity in your home.

On the other hand, the mortgage insurance premiums for new FHA mortgages (post 2013) can’t be removed unless you refinance.

When to choose a conventional mortgage instead

Putting down less money with the FHA mortgage can be a shortcut to homeownership if you don’t have much cash saved or the credit history to get approved for a conventional mortgage.

But, the convenience doesn’t come without strings attached and the additional insurance costs can follow you for the entire loan term. This can get costly.

Furthermore, putting a small sum down on a home means that it will take you quite some time to build up equity. A small down payment can also increase your monthly payments. Homebuyers with a strong credit score should consider saving a bit more money and shopping for a conventional home loan first before thinking the FHA home loan is the only answer to a limited down payment.

You may be able to qualify for a conventional home loan with PMI if you have a down payment of 5% to 10%. A conventional home loan with PMI may not require the same upfront insurance payment as the FHA home loan, so you can find some savings there. Plus, you’re capable of getting rid of PMI without refinancing.

How to shop for an FHA mortgage

If your present credit score and savings make you ineligible for a conventional home loan, the FHA home loan is still a viable option to consider for financing. Just make sure you understand the implications of the extra cost.

Like a conventional mortgage, you need to shop around with multiple FHA-approved lenders to find the most competitive rate. If you’re unfamiliar with FHA-approved lenders in your area, you can go to the HUD website to find a few.

Don’t rush to a decision. If you’re not sure which option (FHA or conventional mortgage) will be the most cost effective for you, ask each lender you shop with to break down the costs for a comparison.

Taylor Gordon
Taylor Gordon |

Taylor Gordon is a writer at MagnifyMoney. You can email Taylor at taylor@magnifymoney.com

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Life Events, Mortgage

Debt-To-Income and Your Mortgage: Will You Qualify?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Purchase agreement for house

When you begin looking for your dream home, it’s fun to fantasize about buying one of the largest and most extravagant properties in your city. In Nashville, that means drooling in front of the gated mansions of country music’s biggest stars. But in reality, your budget is probably closer to that country star’s assistant. Or possibly even their assistant’s assistant.

Also, you probably don’t have the funds to throw down and purchase a home without some type of financing. Unless you’re an investor, or have some wealthy and generous relatives, it’s unlikely you’re shopping with cash.

According to a Realtor Home Buyer and Seller Generational Trends Report, 88% of recent homebuyers financed their purchase. And almost all of Generation Y buyers (97%) have borrowed money. That means these buyers needed to be approved for a mortgage.

Debt-To-Income Ratio

Do you know what keeps loan officers awake at night? It’s not your credit score.

It may surprise prospective homebuyers that debt-to-income ratio (DTI) is actually the most important factor in getting approved for a mortgage. Why? The ability to both afford and pay back a loan is critical. A FICO score may shed light on your past reliability, but it doesn’t indicate whether or not your present budget can handle a loan. However, a DTI ratio can help lenders measure your ability to afford a monthly mortgage payment.

A debt-to-income ratio is calculated by dividing total recurring monthly debt by gross monthly income. For example, if your monthly debts equal $1,000 and your gross monthly income is $4,000, your DTI ratio is $1,000 / $4,000 = .25 or 25%.

Lenders prefer for borrowers to have a debt-to-income ratio of less than 36%, with no more than 28% of that debt being paid toward the mortgage. Generally, it’s difficult for a borrower with a DTI ratio greater than 43% to be qualified for a loan.

If your debt-to-income ratio is more than 43%, you may want to consider working on reducing it before applying for a loan. The two main ways to achieve this are by reducing your monthly recurring debt, increasing your gross monthly income, or a combination of the two.

What Paperwork is Required?

The effects of the financial crisis and The Great Recession have led to increased government regulation throughout the housing market. Lenders are now required to closely scrutinize potential borrowers to make sure they can afford the loans they’ve applied for. This includes verifying income and a complete picture of their finances.

Some lenders are stricter than others. Fannie Mae and Freddie Mac are government agencies with relatively standard income requirements (which we will outline below). However, if you don’t fit the box of a standard 9-5 worker with a W2, you might want to consider a lender like SoFi, which even offers loans up to 90% LTV with no PMI requirements.

You should receive a list of what’s needed from the lender and these items may include:

  • A purchase contract.
  • Individual taxpayer identification and/or Social Security number.
  • Your current home addresses and any previous residences from past two years.
  • Names, account numbers, and current balances of checking, savings, retirement, and credit card accounts.
  • Your bank’s address.
  • The past three months’ checking and savings account statements.
  • Income verification statements (pay stubs, W-2s, or other proof of employment).
  • The past two years’ Federal income-tax returns.
  • Documentation to prove any additional income you received.
  • Balance sheets and tax returns if you are self-employed.
  • Cancelled checks to show payment history for rent and utility bills.
  • Documentation of any additional consumer debts.
  • Gift letters. If family members or organizations are helping you cover the cost, you must have a gift letter stating the money is a gift and will not need to be repaid.

The mortgage underwriting process can take months, so it’s imperative to provide the lender with all paperwork they’ve requested as quickly as you can. They may reach out with questions and ask for further documentation, if needed.

[Learn more about Fannie Mae’s Frequently Asked Underwriting Questions here.]

Why You Need a Good Faith Estimate

Once you’ve handed over the mountains of required paperwork, you’ll want to make sure you have a complete understanding of the full cost of the loan.

Would you blindly agree to the financing for a new car or a new television? Of course not. And you shouldn’t for a mortgage, either. Expenses for credit reports, processing fees, appraisal fees, attorney’s fees, surveying, inspection fees, and title fees can add up quickly. In fact, closing costs can amount to 2-5% of the home’s sale price! The only way to know the true cost of a loan is through a Good Faith Estimate (GFE).

Lenders are required to provide you with a Good Faith Estimate within three days of receiving your mortgage application. Although a GFE can help you understand the full costs of the loan and monthly mortgage payments, legally it can change up to 10%. Be sure to closely compare your GFE with the HUD-1 settlement statement you receive the day before closing. Don’t be afraid to review each item, line-by-line, and ask questions if anything doesn’t look right.

How Much House Can I Really Afford?

Most prospective buyers want to know how much home they can afford. The exact payment for a property depends on the monthly debt payments and the current interest rate. Standard ratios from online calculators can give you a general idea, but ultimately, you’ll need to decide how much you can comfortably add to your budget.

Remember, your monthly mortgage payment can change based on your type of loan, interest rate, homeowner’s insurance, and property taxes. Have you planned for future increases?

It’s also important to consider the cost of home maintenance and repairs. Will a down payment, closing costs, and your new monthly mortgage payments leave you with a comfortable emergency fund?

Lastly, and perhaps most importantly, will taking on a monthly mortgage payment prevent you from saving for future goals like your child’s college education or retirement?

Don’t Go Into the Home Buying Process Blind

Buying a home is the largest purchase many of us will make, and diving into the process blind can make the entire process even more nerve-wracking. Avoid surprises by arming yourself with knowledge before approaching a lender for a pre-approval. That means knowing your credit score, how much you can afford, and what information you’ll be asked for to prove it.

Kate Dore
Kate Dore |

Kate Dore is a writer at MagnifyMoney. You can email Kate at kate@magnifymoney.com

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