What practical steps can I take to improve my chances of getting a loan?

When you’re thinking about buying a home, take a good look at your financial situation from the perspective of a loan officer. For a lender, not all debts are equal.

 

  • 28/36 Ratio
    In the past, lenders often said borrowers could not spend more than 28% of their gross monthly income on housing expenses, and their total debt payments could not exceed 36% of their income for a typical 10% down payment loan.
  • More Flexible Guidelines
    Today, many lenders are more flexible and allow a greater percentage of monthly income to go toward mortgage payments. But they are more stringent on credit card balances. Lenders often count 5% of the balance as a borrower’s monthly payment, instead of the credit card’s minimum payment.
  • Pay Off Strategies
    If you are planning to pay off some debts before you apply for a loan, consider the ones with the largest monthly payment. Many lenders, for example, prefer to have a car loan paid off, because borrowers are not likely to go out and buy a new car right away. On the other hand, if credit cards are paid off, a borrower might start charging again.
  • Near Pay Off Versus Minimum Payment
    If you have a few months left on a loan, lenders sometimes overlook it when calculating your monthly debt ratio. On the other hand, lenders look unfavorably on borrowers who let loans linger for a long time with minimal effort to repay the principal.

The most important factor to lenders, however, is that you pay your bills on time.

Timing seems to be critical. Should I wait until interest rates drop?

Piggy

Time is money. Can you afford to wait? Of course home buyers want to buy when interest rates are at their lowest. When interest rates are at near-record lows, potential buyers or homeowners looking to move up are asking themselves if the time is right to act.

But no one can predict with certainty where rates are headed at any particular time. Waiting for a bottoming out may instead provide time for rates to rise. This chart shows how rises in interest rates can have a dramatic effect on monthly payments.

Monthly Payment

Loan Amount at 7½% at 8½% at 9½%
$50,000 $350 $384 $420
$100,000 $699 $769 $841
$150,000 $1,049 $1,153 $1,261

For information specific to your needs, call or e-mail us today. We’ll be happy to answer your questions.

Will I have to get mortgage insurance?

Quill, Ink and Paper Private mortgage insurance is required by most lenders when the borrower’s down payment is less than 20% of the purchase price. The insurance protects the lender against default on the mortgage.

You may be able to reduce the cost, even if you can’t entirely avoid the expense of mortgage insurance, by asking for lender-paid insurance. Although most lenders don’t advertise the fact, they often will pay the mortgage insurance premiums in exchange for a slightly higher interest rate on the loan. This makes the insurance cost a tax deduction for you because it has become an interest expense instead of a non-deductible insurance premium.

Ask your lender for help.

But, since the higher interest rate stays in place for the duration of the loan, this plan is best for homeowners who plan to move by the time their equity reaches 20%, when the insurance typically would have been discontinued. If you plan to own the home for a long time, paying the insurance premiums yourself may be a better deal. Ask your lender for details.

What, exactly, is escrow?

In / Out Boxes Most lenders require homeowners to pay hazard insurance and taxes, and, in some cases, mortgage insurance in monthly installments. The monthly installments go into an escrow account set up by the lender. The lender then pays the bills from the escrow account. A borrower might ask: “If I never see the bills, how do I know if the monthly set aside is correct?”

Find out correct amount.

  • You may need to contact your taxing authority and insurance carriers to get the amount for the bills. Your copy of the lender’s annual report to the Internal Revenue Service may also break down the expenditures from your escrow account.
  • Here are some danger signs that indicate you may be overpaying into your escrow account:
  • Your escrow payment is increased by the lender, but taxes and insurance have not risen;
  • The lender requests funds to cover private mortgage insurance after your equity exceeds 20%;
  • Your mortgage has been sold by one service company to another and the escrow amount is different;
  • A large amount of money stays in the escrow account;
  • Unanticipated or unexplained deductions are made from the escrow account at closing.

What does it mean to be an “A,” “B,” “C,” or “D” borrower?

Alphabet Blocks Mortgage lenders typically use the letters of the alphabet to rate borrowers. The letters rank the level of risk the lender perceives:

  • “A”
  • signifies prime borrowers, those who always pay bills on time and whose debt-to-income ratio is within acceptable limits;
  • “B”
  • borrowers are those who have been 30 days late on a charge or mortgage payment within the past year;
  • “C”
  • denotes a riskier credit profile, with several 30-day or 60-day late payments; and
  • “D”
  • indicates serious credit problems such as a long-term delinquency or a bankruptcy in the past.

The level of risk determines the interest rate available to the borrower. A borrower with a B, C, or D rating could end up paying a significantly higher interest rate on a mortgage than someone with an A credit rating.

What can you tell me about the debt-to-income ratio lenders use to qualify borrowers?

Abacus Many lenders use two ratios when they decide whether to approve a mortgage. If, for example, the ratios are 28/36, the “front” ratio of 28% means the lender will allow a mortgage payment (including principal, interest, taxes and insurance) of up to 28% of the borrower’s monthly pre-tax income. The “back” ratio of 36% means all loan and credit payments cannot exceed 36% of the borrower’s monthly income.

Call or e-mail us for the answers to your questions. As professionals, we’ve helped people find solutions to all kinds of home-buying dilemmas.