Owning a home is an intrinsic part of the dream for many Americans.
Most of us can’t afford to purchase a home without applying for a mortgage.
Mortgages remain the primary form of lending when it comes to property transactions. The lender grants money to the borrower with good faith that the debtor will pay repay the loan with interest attached. Over a preset period of time, both the debtor and lender benefit if nothing goes awry.
To ensure loan terms can be met, lenders carefully screen borrowers to determine if they are a solid credit risk.
While those with the highest credit scores generally get the best rates, there are four mortgage tenets that make up the legs of the proverbial “mortgage stool.”
Number one is Security
In the case of mortgage lending – the property acts as collateral for the loan. If payments aren’t made, the lender will repossess the property to pay off the remaining loan balance.
That’s the first question a borrower needs to answer. What can they reasonably afford given monthly expenses (debts) and income? There are plenty of online tools that can help calculate the monthly payment – principal and interest plus any mortgage insurance.
Then there are taxes, insurance and maintenance.
When calculating the initial costs, there will be third-party title, lending and escrow fees as well. Those will be due at closing along with an agreed-upon percentage for any real estate agent.
Number two is equity
This is the percentage of value of the property being borrowed – more commonly known as the down payment. This is the percentage of the total cost you can afford to put down for immediate equity in a new home.
It’s been drilled into most of our heads that it takes at least 20 percent of a home purchase price to make a down payment for a mortgage loan, but this is now an antiquated notion.
As home prices have risen over the years, many struggle to save up even 10 percent, and the federal government has taken notice.
Working with Federal Housing Administration, the Veteran’s Administration and the Department of Agriculture, low- to medium-income home buyers can get financing with little or no money down. States and some counties may also have low-down payment programs. Check them out.
Number three: Ability to repay
This segues nicely into the ability to repay – measured by the household’s gross monthly income compared to its debt as a ratio. This is called the Debt to Income ratio – or DTI.
When applying for a mortgage, lenders will usually require proof of available down payment and closing cost dollars as well as enough available, liquid funds to make monthly principal, interest, tax, insurance and mortgage insurance payments in the event income is interrupted.
Underwriters scour financial information to examine whether a potential borrower can reasonably afford to repay the loan.
Most loan products require a minimum of two months in reserves immediately available from documented sources – like savings, checking or investment accounts. Undocumented funds or mattress money may not be used.
Total documented monthly expenses (mainly those that appear on credit reports) divided by the total of each of the borrowers gross monthly income is the “debt to income ratio” or DTI. The percentage of gross income allowed for total expenses is usually about 43 percent, but may change slightly depending on the loan product.
Borrowers are usually required to provide the most recent two years documentation showing adequate income.
And the fourth tenet, the willingness to repay, is measured by a person’s credit report.
A credit score is merged from the reports of the nation’s three largest credit reporting agencies, Equifax, Trans Union and Experian.
Your score is mostly determined by the number of delinquencies and revolving credit accounts – as well as judgments, charge-offs and collections. Scores range from 300 (abysmal) to 850 (pristine).
Lenders can also use one’s credit history, cash flow situation, collateral, capital and other other factors to consider a borrower’s creditworthiness.
New Year, new way
As the New Year really gets rolling, what’s the chance of any of us keeping those New Year’s resolutions?
The most common changes Americans are trying to make in 2016 are losing weight, quitting smoking and getting their financial houses in order.
So if you finished off an entire Boston cream pie last night, then smoked half a pack in shame, take solace.
Follow the four tenets of mortgage lending, get your home loan, and start building wealth for your future.