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How Much do Student Loans Affect Buying a House?

February 28, 2019 By JMcHood

Lenders put a lot of focus on your debt ratio. They want to know that you can afford the new mortgage beyond a reasonable doubt. Without proper proof, you run the risk of default, which can hurt a lender. Even if you’ve kept yourself out of credit card debt, you may still have another debt that can damage your chances of loan approval – student loans.

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This isn’t to say that anyone with student loans cannot get a mortgage, because they can. What it depends on is your debt ratio, not only now, but in the future too. This means that even if you have deferred student loans, it will still affect your loan approval.

Keep reading to see what you can expect if you have student loans.

Using Your Student Loan Payment

If you have student loan debt that you currently pay, chances are your credit report shows the same payment that you make each month. This is what lenders will use to determine your debt ratio. If you aren’t making payments right now, though, things can get a little trickier. Lenders can’t just overlook the impending debt, because you’ll have to pay it someday. Instead, they must include some type of payment when they determine your debt ratio.

Figuring Out Your Payment

If you aren’t making payments right now, you’ll need to know what payment lenders will use to qualify you for a loan. What you should know is that the more proof that you provide of your upcoming payment, the better your chances of approval.

If a lender can’t find sufficient proof of your upcoming payment, they must use 1% of the outstanding balance. That could amount to a very large payment that would probably throw your debt ratio way off where it needs to be. On a $20,000 loan, you’d have a payment of $2,000 used in the calculation. Unless you make a lot of money every month, this wouldn’t leave much room for a new mortgage payment.

If you are in a formal deferment plan, show the lender the paperwork for this plan. It should say somewhere in there how much you are expected to pay once the deferment period ends. If your paperwork doesn’t specify a payment, you can contact your servicing lender to get official proof of the upcoming payment. If you are in a loan forgiveness plan, make sure you have proper proof of when the balance will get forgiven, so the lender can take that into consideration as well.

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If you don’t have paperwork showing an exact payment, but you have proof that the term will be 20 years when you come out of deferment, the lender can do the calculations. They will determine your payment based on the interest rate you have and a 20-year term. This usually comes out much better than the 1% of the balance calculation.

How High can Your Debts Be?

Just how much debt you can have compared to your gross monthly income depends on the chosen loan program. For instance, conforming loans have the toughest requirements. You must have a total debt ratio less than or equal to 36% to qualify. You may find some lenders willing to go a little higher than that if you have compensating factors, though.

FHA and USDA loans allow a maximum DTI of 41% on the back-end and VA loans allow as much as a 43% back-end ratio. The back-end ratio is the total of all of your debts including the new mortgage. It includes things like your minimum credit card payments, installment loan payments, student loan payments, and personal loan payments.

The lower you can get your back-end DTI, the better your chances of loan approval become. But, as we said above, you may be able to get by with a higher DTI if you have compensating factors.

What are Compensating Factors?

Lenders look at the big picture when determining if you qualify for a loan. They don’t look just at your credit score or just at your debt ratio and either approve or deny your loan request. Instead, they look at everything. For example, if you have a high credit score, but also have a high DTI, they still may approve you because of your high credit score. If you had a low credit score and a high DTI, your chances of approval are much smaller.

Aside from credit scores and DTIs, lenders also look at your stability in other areas of your life. Take employment for example. If you have a steady employment history, lenders may use that as a compensating factor for a slightly elevated DTI. If you have steadily increasing income, that could also serve as a compensating factor as it proves that you continually improve your income, which lowers your DTI.

Of course, lenders look at your credit score and DTI the most, but they aren’t the only deciding factors. Make all aspects of your loan application look as attractive as possible in order to get the loan approval that you need. If you do have student loans, make sure that you get as much proof as possible of their impending payment so that you can get qualified for the mortgage you need.

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Home Improvements: Can you Use VA Financing to Pay for Them?

February 14, 2019 By JMcHood

If you are a veteran with VA loan eligibility, you probably know that you can buy a home with no down payment. But, did you also know that you can buy a home that isn’t in ‘good’ condition and repair it with the funds provided by the VA loan? The VA, like the FHA, has a home improvement loan that makes this possible.

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Keep reading to find out how you can take advantage of this program.

The VA Renovation Loan

The VA does allow you to purchase a home that doesn’t pass the VA appraisal requirements and use funds from the loan to fix the home up to code. Because the VA already allows 100% financing to purchase a home, though, not too many lenders allow this type of financing. If you only want VA financing, you’ll have to shop around to find a lender willing to offer this program.

In order to get enough financing to purchase and fix up a home, you must:

  • Submit a bid from the contractor providing all of the details of the renovation
  • You can only borrow the lesser of the purchase price plus renovations or the expected value of the home after the renovations
  • You must prove that the home passes the VA requirements after renovations are complete
  • All renovations must be necessary and not luxurious
  • You must have a contractor do the work – you cannot do it yourself

Alternatives to the VA Renovation Loan

What happens if you can’t find a VA lender willing to write a VA renovation loan or you don’t meet the above guidelines? You have one other option – the FHA 203K loan.

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The FHA 203K loan is the FHA’s version of the renovation loan. The main difference is that you will need a down payment in order to buy the home. It’s only 3.5% of the purchase price of the home, though. You can even receive 100% of the funds as a gift if necessary.

The FHA 203K loan has two options:

  • The streamline 203K loan – This loan provides you with up to $35,000 in renovations on top of the purchase price of the home. You cannot make structural changes, but you can make any other changes that fit within the $35,000 and make the home meet the necessary code
  • The full 203K loan – You can borrow up to 110% of the after-improved value of the home. You can make structural changes with this loan. Once you make the necessary changes to make the home up to code, you can make any cosmetic or optional changes that you desire as long as they fit into the loan amount

If the home you want to buy passes the VA appraisal, but it just needs other work that you would prefer, you can buy the home with your VA loan and then refinance it down the road. The refinance would be a part of the VA cash-out refinance program.

This program is a little more lenient because the VA doesn’t specify what you need to do with the funds. You can make as many or as few changes as you want with the money. With this program, you can borrow up to 100% of the value of the home at the time of the refinance. If you wait until you have a little equity, you can get the funds you need to renovate the home.

The VA loan can be a way to help you pay for home renovations, but it won’t be the easiest route. If you can manage to get a down payment for the home, the FHA 203K loan may be the easier route to take. If you can get the home to pass the appraisal, you can even wait and take out a cash-out refinance once your home is worth enough. Explore your options and decide which one will cost you the least and give you the greatest return on your investment.

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Understanding the FHA Loan Limits

January 10, 2019 By JMcHood

If you need a flexible loan with guidelines with low credit score requirements and high debt ratio allowances, you may want to explore the FHA loan. This loan allows a credit score as low as 580 and debt ratios as high as 43% in some cases.

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Many people want to know just how much they can borrow with the FHA loan, though. Keep reading to find out how much you may be able to borrow.

The Basics

FHA loans typically follow the conventional loan maximums. This year that means a maximum loan of $453,100. This is the case in most areas. However, there are some ‘high cost’ areas where you can borrow more than this because the cost of living is higher.

The Upper FHA Loan Limits

The FHA labels counties based on their cost of living and average home price. You’ll see low-cost counties, high-cost counties and average counties.

The limit for low-cost counties is $294,515. This is the most you can borrow in what the FHA considers a low-cost county. The limit for high-cost counties is $679,650. If your county doesn’t fall within the low-cost or high-cost counties, it will fall somewhere in between. This means your county will have a limit higher than the low-cost county, but lower than the high-cost county.

What do Loan Limits Mean?

So how does the loan limit affect you? Let’s say your county loan limit is $453,100. Does that mean that you can borrow that much?

It doesn’t. You have to qualify for the loan amount, which is a lot different than being eligible for it. You must qualify or prove that you have the credit score, income, and debt ratio to afford for the loan. Luckily, FHA loans have flexible guidelines allowing you some wiggle room.

In order to qualify for an FHA loan, you’ll need the following basic requirements:

  • 580 credit score or higher – The FHA allows a credit score as low as 580, but not all lenders will allow it. Check with induvial lenders to find out their requirements.
  • 31% housing ratio – The FHA allows you to have a housing payment that equals as much as 31% of your gross monthly income (income before taxes).
  • 41% total debt ratio – The FHA allows you to have a total debt ratio that equals up to 41% of your gross monthly income. In some cases, lenders may allow as much as a 43% ratio.
  • Stable income – You must prove that your income is stable and reliable. It helps if you’ve been at the same job for the last two years, but if you have a newer job, don’t worry. You just need to prove stability and reliability.
  • 5% down payment – The FHA requires at least a 3.5% down payment on the home, but you can make the down payment from your own funds or gift funds from relatives or an employer.

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That’s all that the FHA really requires. It’s a flexible loan program for many. It’s not just a first-time homebuyer’s loan as many people think of the FHA loan. If you need flexible guidelines, you may qualify for this loan.

The FHA’s Role

Something to keep in mind is that the FHA doesn’t underwrite or fund the loan. Your lender is in full control of whether or not you get approved. The FHA approves certain lenders to write loans in their name. As long as the lender follows the FHA rules, the FHA will guarantee the loan.

The guarantee the FHA provides is for the lender. They promise the lender that they will pay them back a portion of the money that they lose should you default. Even with that guaranty, some lenders make the guidelines a little stricter. They add what’s called lender overlays. They make it a little harder to get the loan so that the risk of default decreases.

FHA loans have flexible guidelines and varying loan limits. You can find the loan limits for your county here or you can ask your lender. This will give you an idea if FHA financing will be a good option for you based on the price of the home that you want to buy.

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What are Reasonable Seller Concessions to ask For?

September 13, 2018 By JMcHood

Sometimes the cost of closing on a home purchase can be overwhelming. Not only do you need money for the down payment, but you need between 3% and 5% of the home’s value for closing costs. If you can’t come up with enough money for everything, you may be able to ask the seller for help with seller concessions.

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What are Seller Concessions?

Technically, seller concessions are funds a seller gives you to help you pay your closing costs. In some cases, though, they are funds that the seller provides to help you cover the cost of repairs. This is a common scenario when something is wrong with the home and the seller doesn’t want to use the time or resources necessary to fix it before the closing.

Before you negotiate seller concessions into your loan contract, learn the maximum amount allowed by each loan program:

  • Conventional loans – 3% of the purchase price of the home if you put 10% or less down on the home. The amount increases to 6% if you put between 10% and 25% down on the home.
  • FHA loans – 6% of the purchase price of the home no matter how much you put down on the home
  • VA loans – 4% of the purchase price of the home plus the cost of reasonable and customary closing costs
  • USDA loans – 6% of the purchase price of the home

These limits only apply if the appraised value is as much as or higher than the sales price of the home. If you agree to pay more than the price of the home, the limits are calculated based on the value of the home.

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Common Seller Concessions to Request

Every situation will differ, but below are some of the most common and reasonable concessions to ask a seller for when buying a home:

  • Repairs to make the home functional – If there’s something wrong with the electrical system, plumbing, or roof, it’s safe to ask the seller for concessions. This, of course, only applies if the home passes the appraisal. If the appraiser doesn’t think the home is safe, a lender won’t give you a loan for it. If the repairs are something that doesn’t affect the home’s value but may affect your use of the home, though, it’s reasonable to ask for help with it.
  • Closing costs – First-time homebuyers are often shocked at the amount of closing costs they have to pay. If it makes the loan unaffordable, a seller may be willing to step in and pay some or all of the closing costs to make the purchase possible for you. It’s a win-win for both sides of the equation.
  • Discount points – If you are going to stay in the home for the long-term, you may want to ask the seller to pay your discount points, if you don’t have the cash to do so. This will help you get a lower interest rate, which will save you money over the life of the loan.
  • Real estate taxes – The taxes on a home can be another reason you need an excessive amount of cash at the closing. If the taxes make the house unaffordable because of the combination of closing costs and the down payment, the seller may be able to help.

Keep in mind, seller concessions ultimately increase the price you pay for the home. All sellers have a ‘bottom line’ figure they want for the home. If you ask for concessions, they may agree, but will increase the price of the home accordingly. Of course, they can only increase it as much as the value of the home or they risk your ability to secure financing.

What this means for you is a larger loan amount. You essentially borrow the money that the seller ‘gives’ you. With a higher loan amount, you have a higher mortgage payment and pay more for the loan over its entirety. If this is your ‘forever’ home, though, it may make sense to do so because you’ll be able to afford the costs of closing and/or repairs that make the house a home for you.

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Are Tax Returns Needed to Refinance Your Mortgage?

August 30, 2018 By JMcHood

You know you have to verify your income in order to refinance your mortgage. Unless, of course, you qualify for the VA streamline or FHA streamline loan. You aren’t required to verify your income if you use a streamline program.

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But just what does it mean to verify your income? Do you need paystubs, W-2s, and tax returns?

There isn’t a straight answer to this question. It depends on the situation. Some borrowers will have to provide their tax returns, while others won’t need to provide them.

Salaried and Hourly Borrowers

Salaried and hourly borrowers typically don’t have to provide their tax returns when refinancing their mortgage. If you make a yearly salary and it stays the same all year, your lender won’t have a need for your tax returns. Your paystubs and W-2s will show the necessary information for the lender to qualify you for the loan.

Hourly employees are also exempt from providing their tax returns. Hourly employees will have to provide their paystubs covering the last 30 days and their W-2s covering the last 2 years. This way the lender can determine a 2-year average of your income. They do this in the event that your hours vary, which would give you varying income. Taking a 2-year average helps the lender account for the highs and lows that your income may experience.

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Borrowers Paid on Commission

If you work on commission and it makes up more than 25% of your income, you will need to provide your tax returns for the last 2 years. Lenders will look at your tax returns to see if you have any unreimbursed employee expenses that they must deduct from your income. They will also look for any deductions that you take that are work-related. Lenders are required to use your adjusted gross income as it is reported on your tax returns. If you claim many deductions, it could affect your ability to secure a mortgage.

Self-Employed Borrowers

Finally, we have self-employed borrowers. These borrowers definitely need to provide the last two years of their tax returns. Just like borrowers paid on commission, lenders need to determine the adjusted gross income of the self-employed borrower.

Because the lender will use your AGI as reported on your tax returns, it works to your benefit to avoid taking too many deductions during the 2 years leading up to your loan application. Even though this will increase your tax liability temporarily, it will also increase your chances of securing a mortgage.

Don’t worry if your lender asks for your tax returns. It’s just another way for them to verify your income. As long as your tax returns are legitimate and they reflect what your paystubs and/or W-2s already show, you are in good hands. The lender will use your tax returns to calculate your gross monthly income, which they then use to determine your debt ratio. This is the lender’s way of determining if you can afford the loan and if you are a high risk of default.

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Is Gross Income Before or After Taxes?

July 5, 2018 By JMcHood

When you apply for a mortgage, your lender will ask about your gross income. You might be surprised to learn that this isn’t the money you bring home on your paycheck. It’s the full amount of your income before taxes and other deductions.

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Keep reading to learn why lenders use this number and which number you should use for your own budget.

Why Lenders Use Gross Income

The main reason lenders rely on your gross income rather than the net income is its reliability. Your net income is your total salary minus taxes and other deductions. These deductions could change often, so using your net income might give lenders inconsistent results. For example, if your company changes insurance plans or you change your tax filing status, your net income may change. Even if it’s only a $100 difference, it may still alter your ability to secure a loan.

Another reason lenders use gross income is that it’s a number you likely know off the top of your head. If someone asks you how much money you make per year, you probably know the salary your employer pays you better than the amount of your paycheck and how it converts into your annual salary. For example, it’s much easier to rattle off $75,000 per year rather than figuring out how your $5,267 monthly check converts into an annual salary.

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How Lenders Use Your Gross Income

Lenders use your gross income to determine the maximum amount of your loan payment. Each loan program is different, but as a general rule, you can use the conventional loan guidelines of 28% and 36%. In other words, you can have a mortgage payment that is up to 28% of your gross monthly income. But lenders will also look at your total debt ratio. This is the total of all of your monthly debts including your mortgage payment – this figure shouldn’t exceed 36% of your gross monthly income.

Why You Should Focus on Net Income

Now just because a lender focuses on your gross income doesn’t mean you should use this figure. Your net income is the money you actually take home. This is the money you can use to pay your bills. You want to make sure that the mortgage payment you take on fits into that budget.

A good way to figure it out is to put the potential mortgage payment into your monthly budget. Are you comfortable with the payment? Do you have enough money left over after paying your bills to cover your living expenses?

If you focused on your gross monthly income, you might take on a mortgage payment that exceeds what you bring in or what you can comfortably afford. Some people don’t want to take on debts that eat into their disposable income. Many borrowers don’t want to live paycheck-to-paycheck. These are all reasons why you should focus on the net income to make sure you are taking on a loan you can afford.

Your lender will focus on your gross income, so make sure you have those numbers handy when you apply for a loan. But when you think about what you can afford, your net income is a better figure to consider to ensure that you only take on what you can afford.

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The Biggest Factors That Affect Your Mortgage Eligibility

May 17, 2018 By JMcHood

When you apply for a home loan, there are many things that affect your eligibility. Just having a great credit score or a low debt ratio isn’t enough. Lenders look at the big picture. It’s almost like a puzzle. They take each piece of the puzzle and put it together to figure out your level of risk. This means that negative factors can be offset by positive factors and vice versa.

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So what does a lender look at the most when deciding whether to approve you for a loan? Keep reading to find out.

Your Credit Score Affects Your Eligibility

It’s no secret that the first thing most lenders look at is your credit score. This is a snapshot of your financial responsibility. A high score generally means that you are financially responsible. In other words, you don’t overextend yourself and you pay your bills on time. A low score generally means that you are financially irresponsible. You may pay your bills late or your overextended yourself, making it hard to keep up with your bills.

Each loan program and lender has their own credit score requirements. In general, you can expect the following requirements:

  • Conventional loans – 680 minimum credit score
  • FHA loan – 580 minimum credit score
  • VA loan – 620 credit score
  • USDA loan – 640 credit score

Each lender will have their own minimum requirements, but these are the industry standards. As you shop around, you may find that different lenders have higher credit score requirements, especially for FHA loans.

Your Outstanding Debt is a Factor

How much debt you have outstanding know affects your debt ratio. Your debt ratio is one of the largest factors in figuring out your mortgage eligibility. The more money you already have committed to previous debts each month, the higher your risk of default on a mortgage becomes.

Each loan program has their own debt ratio guidelines, but as a general rule, the total debt ratio cannot exceed 43% for any loan. The total debt ratio includes all of your monthly debts, such as car loans, student loans, and credit card debts as well as the proposed mortgage payment.

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The various loan program debt ratio requirements include:

  • Conventional loan – 28% housing ratio and 36% total debt ratio
  • FHA loan – 31% housing ratio and 43% total debt ratio
  • VA loan – 43% total debt ratio (they don’t monitor the housing ratio)
  • USDA loan – 29% housing ratio and 41% total debt ratio

Again, each lender will have their own requirements. In order to lower your debt ratio, it’s a good idea to pay debts down or completely off if you can.

Your Down Payment Affects Your Chances

The more money you borrow in relation to the home’s value, the riskier you become. Lenders look at what they call the loan-to-value-ratio. In other words, how much money do you borrow compared to the home’s value? The more money you put down on the home, the less risk you pose to the lender.

You decrease your LTV by making a larger down payment. Conventional loans are known for their 20% down payment requirement. This is the point where you do not have to pay Private Mortgage Insurance because lenders feel this is enough ‘skin in the game’ to make you stay on top of your mortgage payments. If you put less than 20% down, the PMI covers the lender should you default.

Government-backed loans require little to no down payment, but it may still affect your approval. If you have a low credit score, high debt ratio, and no down payment, many lenders will likely consider you ‘high risk’, which could affect your mortgage eligibility.

Your Employment History Counts Too

Finally, lenders look at your employment history. The industry standard is two consecutive years at the same job. This shows the lender that you are consistent and reliable. What if you change jobs before you hold a job for two years? Are you instantly ineligible?

Today the 2-year history isn’t mandatory, but it’s still desired. The longer your employment history, the more the lender can rely on your ability to stay consistent with your job/income. This helps the lender feel good about the fact that you will be able to make your mortgage payments and won’t make rash decisions, leaving your job and putting your mortgage at risk of default.

Lenders put all of these pieces together to determine your loan eligibility. One ‘bad’ factor won’t automatically disqualify you, just as one ‘good’ factor won’t automatically make you eligible. Make your loan qualifying factors as good as possible in order to provide lenders with the picture that you can and will make your mortgage payments on time for the best chances at approval.

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What do Mortgage Underwriters Look for in Bank Statements?

April 26, 2018 By JMcHood

If we had to pick one area that underwriters spend a lot of time when evaluating a mortgage application, it’s the bank statements. Underwriters can tell a lot from the bank statement. It’s more than a way for them to verify that you have the funds necessary to close the loan.

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Your bank statements also let a lender know how comfortably you can afford your monthly mortgage payment among other things. Keep reading to see what red flags lenders may see on your statements.

Do You Have Enough Money?

First, a lender is going to make sure you have enough money for the down payment and closing costs. If you don’t have enough money, then the loan will not go through. The underwriter’s job would be done until you could come up with the money for the closing costs and down payment.

If you are receiving gift funds, you’ll have to supply the Gift Letter from the donor as well as the donor’s bank statements. Don’t think you’re off the hook with your bank documents, though. The lender will need proof that you deposited the gift funds into your account as well. This still gives them access to your bank documents, allowing them a peek inside your financial life.

Do you Have Large Deposits?

Speaking of gift funds, lenders look very closely at any large deposits you put in your bank account. If the money doesn’t coincide with your regular income, you can bet the underwriter will ask questions. They will flag the deposit and need to source it. In other words, they need proof of where the money originated.

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Let’s say it was something as simple as you sold stocks to help you have enough for a down payment. That’s great, but you have to prove it. You cannot just tell the lender that you sold stock XYZ and put the proceeds in your bank account. You’ll have to show the lender the sale of the stocks, proof of the receipt of the funds, and the deposit ticket for depositing the funds. Every dollar amount must match to the penny, or the underwriter will continue asking questions.

Any large deposits that you cannot source cannot be used. There is too high of a risk that the money is borrowed money and could leave you with a higher debt ratio than the lender assumes.

Do You Have Many Overdraft Charges?

If you consistently overdraft your bank account, it will give the underwriter another red flag. Overdrafts are a sign of poor financial management. This could lead to difficulty securing the loan. Generally, though, the lender only needs the last 2 months of bank statements for loan approval. If you don’t have any overdrafts during that time, you might be okay.

It’s a good rule of thumb to stay within your financial means, though. You don’t want any type of slip up to cause your loan to get tossed out the window. Underwriters are supposed to use your bank statements to make sure you have the cash to bring to the closing that you said you would. It shouldn’t be another way for them to question your ability to afford the loan after you already worked hard to prove that you could afford it.

Your bank statements are supposed to be confirmation to the lender that you can afford the home you agreed to buy. It’s a way to show the lender that the funds you will use are yours or those from a documented gift. Be aware, though, that lenders could use these statements to further scrutinize your income and financial management. Make sure your last two months of bank statements are as clean as possible to ensure that you get the approval you need.

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What Is the Longest term Mortgage Lenders Allow?

April 5, 2018 By JMcHood

If you surveyed a handful of lenders, you’d likely find that the longest average term they allow is 30 years. Perhaps it’s because it’s the most common or because it’s the most risk they are willing to take. This doesn’t mean you can’t find mortgages that last 40 or 50 years, but they are much fewer and further between.

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For comparison purposes, we’ll focus on the 40-year term, as it’s the longest a majority of lenders in the US will go today.

Why Would You Want a Longer Term?

40 or even 50 years seems like a really long time to have a mortgage. So why would anyone even consider it? Basically, it’s to increase affordability. If you want to buy a house outside of your budget on a 30-year loan, you may have a better chance with a 40 or 50-year loan. However, is it worth it?

The longer term means you pay on the loan for another 10 or 20 years. That might not sound horrible, but don’t forget about the interest. You’ll pay interest for another 120 – 240 payments on top of the standard 360 mortgage payments. That could mean thousands of dollars. This is something to consider.

The Benefits of a Longer Mortgage Term

Putting the larger amount of interest aside, let’s look at the benefits of taking a longer term.

  • Helps you afford a home – If your debt ratios are just too high, meaning your income is too low, you may benefit from stretching the payments out, making them lower. This, in turn, helps lower your debt ratio.
  • Help you stay out of debt – If you can take on a lower mortgage payment, you may have more disposable income to handle the cost of daily living. This could prevent you from racking up credit cards, which could work to your advantage in the future. It decreases the amount of interest you pay and helps you save money for emergencies, retirement, vacations, and more.
  • Help you get a home right out of college – If your starting income isn’t nearly as high as your potential based on your degree, the longer mortgage term can help you afford a home now, while you wait for your income to increase. Down the road, you can have the goal to refinance your mortgage into a shorter term if it makes sense to do so.

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The Disadvantages of a Longer Mortgage Term

As we already discussed above, a longer mortgage term costs you a lot more in the end. All things being equal (even though they probably wouldn’t), look at the difference between the 30 and 40-year term on a $200,000 loan:

  • 30-year term – You’d pay $143,700 in interest
  • 40-year term – You’d pay $201,200 in interest

That’s $57,000 more in interest. There are probably a lot of things you can do with that money, including saving for retirement!

It’s not just because you pay interest over a longer period, though. There are a few more reasons:

  • You’ll pay higher interest rates – Lenders will likely give you a higher interest rate due to the risk that the longer term gives them. It’s not unusual to see an interest rate 0.5% to 1% higher as a result of the longer amortization period.
  • You’ll have a mortgage into your golden years – If you are 25 years-old when you take out a 40-year mortgage, you won’t pay it off until you are 65-years old if you make the standard payment. That could take away from retirement savings and plans you have as you get older.
  • You’ll have less home equity – The longer you stretch out a loan’s term, the less principal you pay with each payment. If you went to sell your home, you’d see a large portion of the funds from the sale go back to the bank to pay off your mortgage rather than being put in your pocket.

So what should you do? Generally, you should aim for the lowest term you can afford. Don’t worry if that means 40 years. While it’s not ideal, you know going into it what you have to do. Most mortgage programs allow prepayment. If you can make extra payments regularly, you’ll knock principal off the loan without much effort. Even an extra $100 a month can make a large difference.

Talk with several mortgage lenders to see what deals you can get. If a 30-year mortgage seems unaffordable at one lender, it doesn’t mean that’s the case for all lenders. Maybe you can find a lender with an interest rate low enough that you can afford the payment.

The key is to shop around and find the deal that is right for you. When you compare loans, make sure you compare apples-to-apples. In other words, don’t compare a 30-year term to a 40-year term. Once you see which loan is most affordable now and in the long run, you can make the decision that works best for you.

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What Is an Acceptable Expense Ratio for Home Buyers?

February 1, 2018 By JMcHood

Your income determines how much loan you can afford, but it’s not the only factor. Your expense ratio is one of the largest determining factors. The amount of your income committed to your monthly bills shows lenders what you have to spend on a mortgage. If your ratios are too high, you become what they call a ‘high risk borrower.’

The Front-End Expense Ratio

The front-end expense ratio is how the new mortgage payment will affect your income. It shows lenders how much the monthly payment will stress your income. It takes into account the principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance.

Here’s an example:

You make $75,000 per year. Monthly that comes out to $6,250. This is your gross monthly income. Let’s say you apply for a $200,000 mortgage and the lender quotes you a 5% rate. Your principal and interest payment would be $1,074.

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Don’t forget, you have to add on real estate taxes and homeowner’s insurance. In this case, let’s say your real estate taxes are $5,000 per year and your homeowner’s insurance is $900 annually. This means $417 a month for taxes and $75 a month for insurance. Your total housing payment, assuming you don’t need mortgage insurance equals $1,566.

To figure out your expense ratio, you would do the following:

$1,566/$6,250 = 25%

The type of mortgage program you apply for will determine if this is an acceptable ratio. In general, the following ratios apply:

  • Conventional loans – 28%
  • FHA loans – 31%
  • USDA loans – 29%

The Back-End Expense Ratio

Your front-end ratio isn’t the only ratio lenders worry about. They also consider the back-end expense ratio. In other words, how much money you must pay out every month compared to your income. This ratio includes not only the new monthly mortgage payment but also any other debts you have. A few examples include:

  • Minimum credit card payments
  • Car loans
  • Student loans
  • Personal loans

Any payments that report on the credit report must be included in your debt ratio. The lender will total up the monthly payments and add them to the potential mortgage payment.

Let’s say you have the following:

  • Car loan $300
  • Credit card payments $75
  • Personal loan $150

This is a total of $525. Using the above example, we’ll add this to the mortgage payment of $1,566. This gives you a total debt ratio of:

$2,091/$6,250 = 33%

Just like the front-end ratio, each program has a maximum back-end ratio:

  • Conventional loans – 36%
  • FHA loans – 43%
  • USDA loans – 41%

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In our example, you would be eligible for most programs based on your back-end ratio.

Other Factors Affecting Your Mortgage Application

Of course, the expense ratio isn’t the only factor affecting your mortgage approval. The lender will look at the big picture. They usually start with your credit score. This determines if you are even eligible for the program. Every program has a minimum, but it is also up to lender discretion. The basic requirements are as follows:

  • Conventional loans require at least a 620 score, but most lenders require a higher score, usually one of at least 680
  • FHA loans require at least a 580, but again, most lenders require a higher score
  • USDA loans require at least a 640 credit score

After your credit score, lenders look at your type and length of income/employment, your assets, and your credit history.

It’s like a big puzzle that they put together. One ‘bad’ factor doesn’t necessarily mean you won’t qualify for the loan. Take the expense ratio for example. If you have a 37% back-end ratio, it doesn’t mean you are automatically ineligible for the program. The lender will look at your income, employment, and assets. They look for what they call compensating factors. A few good ones are as follows:

  • Do you have a high credit score? Having a score that exceeds the minimum, putting you in the ‘excellent’ category can help your chances of approval. It shows financial responsibility and that you can handle a slightly higher debt ratio.
  • Do you have assets on hand? How many mortgage payments would they cover? Lenders call these reserves. The more reserves you have, the greater your chance of approval.
  • Have you been at the same job for several years? Job stability shows the lender that you are consistent and dependable.
  • Has your income steadily increased over the past few years? This shows the lender more financial responsibility and the potential to progress.

Your expense ratio is a big piece of the puzzle, but it’s not the only piece. Make sure to work on every aspect of your mortgage profile before applying. The debt ratios are set to keep risky loans away, but there are ways around it.

Choosing the Right Lender

If one lender turns you down, you can always apply with another. In fact, getting at least 3 quotes for your loan is the best way to save money. You’ll determine which loan is the best fit for you. It also allows you to get the best loan for your money.

You’ll find that different lenders charge different rates and fees. You may find yourself taking a loan with a slightly higher rate, but lower fees. It all depends on your situation and what you can afford. Take your time finding the loan that works for you – it’s one of the largest investments you’ll make in life.

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