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Debt-to-income ratios

When you apply for a mortgage, your lender will analyze your debt ratios, which are also known as your debt-to-income ratios, or DTI. Lenders calculate DTIs to ensure you have enough income to comfortably pay for a new mortgage while still being able to pay your other monthly debts.

Housing ratio or “front-end ratio”
Your lender will add up your anticipated monthly mortgage payment plus other monthly costs of homeownership. Other costs of homeownership could include homeowner association (HOA) fees, property taxes, mortgage insurance and homeowner’s insurance. Normally, some of these expenses are included in your monthly mortgage payment. To calculate your housing ratio or front-end ratio, your lender will divide your anticipated mortgage payment and homeownership expenses by the amount of gross monthly income.

Total debt ratio or “back-end ratio”
In addition to calculating your housing ratio, a lender will also analyze your total debt ratio. At this time your other installment and revolving debts will be analyzed and added together. Installment and revolving debts will appear on your credit report. These payments are expenses like minimum monthly credit card payments, student loan payments, alimony, child support, car payments, etc. Your lender will add up all your monthly installment and revolving debts in addition to your estimated monthly mortgage payment and housing expenses and divide that number by your monthly gross income.

Generally, your front-end and back-end debt ratios should be 28 percent and 36 percent or lower.

  • FHA limits are currently 31/43, though these can be higher with justification from the lender.
  • VA limits are only calculated with one DTI of 41.
  • USDA limits are 29/41.

Some lenders may be able to qualify you with a much higher back-end ratio by getting you approved for a non-conforming loan. A non-conforming loan does not conform to purchasing guidelines set by Fannie Mae and Freddie Mac. These purchasing guidelines usually have to do with standards or limitations on credit scores, LTVs and DTI ratios. Generally non-conforming loans are considered riskier, and a borrower typically has to pay more than they would for a conforming loan.

How to fill out mortgage paperwork

To get a loan to buy a home, you’ll need to fill out a mortgage application. This application—typically called the Uniform Residential Loan Application, or Fannie Mae Form No. 1003—will help the lender determine whether you’re a good candidate for a loan and how much they’ll let you borrow. You can fill this form out to get pre-approved for a loan even before you find the property you want, and/or you can use it once you find the property you want and are applying to get a loan.

If you’ve never filled out a form like this before, you might feel a little intimidated. But don’t worry: You will work with your lender to complete the form. And this simple guide will walk you through all the types of information that you or your lender will need to provide for a mortgage application, so you know what to expect going in.

You, with the help of the lender, must list which type of loan you want—FHA, VA, conventional or USDA/Rural Housing Service—the amount and length of the loan, the interest rate and some other details about the type of mortgage and its terms.

You will need to write in the details of the property you want to buy—its address, the year built, the legal description of the property and the number of units in the building. Then you will need to write in why you want the loan: Is it to purchase the property, a refinance, a construction loan or some other reason? (If the property is a refinance or construction loan, you will need to provide additional details on the improvements you plan to make, existing liens and a few other details.) You will also need to list whose names the title will be in and the source of the down payment.

You and your co-borrower (if applicable) must fill in your personal information, including your name, current address (and whether you rent or own), previous address—if less than two years—(and whether you rented or owned), Social Security number, phone number, marital status, date of birth, number of years of school and number of dependents. The lender will use this information to run your credit report.

You and your co-borrower (if applicable) will need to list out details of your employment. This includes the name, address and phone number of your employer; your position and job title; the type of business; the number of years you’ve held that position; and how long you’ve been in that field. If you’ve been in that position for less than two years, you’ll need to fill out previous employment details as well. Your lender will call your employer to verify employment. If you are self-employed, you will likely need to provide a minimum of two years’ personal and business tax returns and current financial statements.

You and your co-borrower (if applicable) will need to include details about your gross income—this includes your base employment income, overtime, bonuses, commissions, income from dividends, interest, rental income—and combined monthly housing expenses. These expenses include current rent or mortgage payment, insurance, taxes and homeowners association fees—basically any expense related to housing.

You and your co-borrower (if applicable) will need to list out what you own (your assets) and what you owe (your liabilities). Assets include bank accounts, investments, real estate, cars and businesses owned; you will need to list out the details (name of bank, account number) and market value for each of these. Liabilities include credit card balances, installment loans (i.e., car loans, student loans, boat loans), alimony and child support; for each, you will need to include account number, monthly payment amount, months left to pay and total unpaid balance. This allows the lender to analyze your current debt structure so that they can determine the amount of mortgage loan that you qualify for. The lender will also analyze your cash accounts to determine whether you have the necessary down payment amount and cash reserves required for the loan transaction.

The lender will write out the details of the loan—the purchase price, estimated closing costs, estimated prepaid items, loan amount and other details about the loan—on this application.

You will need to answer yes or no to questions about whether you have declared bankruptcy within the past seven years, whether there are any outstanding judgments against you and whether you have had a property or loan foreclosed upon or have been a party to a lawsuit. If you answer yes to any of these questions, you will need to provide further explanation.

You will need to sign this application in two places. At the top of the application, you and the co-borrower (if applicable) need to sign the form to acknowledge that you intend to apply for joint credit if applicable . You also need to check a box to show whether or not the income or assets of the co-borrower (if applicable) should be used by the lender when determining the loan details. At the bottom of the loan application, you and your co-borrower will need to sign once again, acknowledging that all of the information provided on the loan application is true.

On the last section of the mortgage application, you will be asked about your race, ethnicity and gender but are not required to provide such information. The government uses this for its own internal monitoring process.

Loan to value explained

Your LTV Ratio is a comparison between the value of your loan and the amount of your home. To determine your LTV, your lender will divide your loan amount by the lesser of the home’s appraised value or purchase price (if applicable).

Lenders will evaluate your loan-to-value ratio while they are underwriting your loan. In general, borrowers with lower LTV ratios will qualify for lower mortgage rates than borrowers with higher LTV ratios. Borrowers who have a lower LTV ratio are considered less risky to lenders because they have more equity in their homes.

Your LTV ratio will also determine whether you have to pay private mortgage insurance. For conventional loans, borrowers who want to avoid paying private mortgage insurance will need to make a down payment of 20 percent of the value of the home. For government loans like FHA, USDA, VA and other specialty loan types, each has its own unique requirements for PMI. As an example, a VA loan does not require mortgage insurance. Your mortgage banker will be able to discuss these options with you.

Borrowers with an extremely high LTV ratio are considered “upside-down” on their mortgage, i.e., the value of their house is less than their loan amount. Although this is not ideal, you may still be able to refinance. Special refinancing programs exist for borrowers with an LTV over 100 percent. The most common high LTV refinance program is the HARP Refinance program. If you have a FHA loan and have a high LTV, you may be eligible for a FHA streamline loan.

Mortgage points

There are several costs involved in mortgage loan transactions. One of the closing costs charged by the lender is called ‘mortgage points’ or just ‘points.’ One ‘point’ is the equivalent of 1 percent of the loan amount. For example, if you purchase a home and borrow $100,000, every point would cost $1,000. These points are charged by the lender to obtain the amount borrowed at a particular rate. Points can be negotiated between the buyer and seller and can be paid by either party.

Additionally, there are two kinds of mortgage points: origination fees and discount points.

Origination fees are fees charged by a lender for the cost of originating the loan. In other words, this is the lender’s income for doing the loan. Origination fees may or may not be tax deductible—you should check with tax adviser.

Discount points are also charged by the lender at closing, but these points actually “buy down” the interest rate that is charged on the mortgage loan. Discount points are considered prepaid interest and are tax deductible. The more discount points paid on the loan, the lower the interest rate. Lenders’ charges for points can range from 0 to as many as the borrower would like to pay to lower their rate (usually no more than 3 or 4).

Owning vs. renting

Buying a home in order to build equity is one of the main financial reasons prospective buyers jump into the market, but many people also yearn for the satisfaction of home ownership.

Painting your rental apartment walls mango or some other trendy color may put your security deposit in jeopardy. But taking that same sense of color style and applying it to a tired room in an old house you just purchased is called “sweat equity.” That has a nice ring to it.

There is definitely an upside to renting:

  • Flexibility. Check out neighborhoods if you are new to town or are researching where you want to buy. By renting you can test an area without committing to it.
  • Uncertainty in your career. If you think you might need to move in the near future, or are mulling job changes that span several areas of town or are located elsewhere in the country, you might want to rent, since buying ties you down to a greater extent.
  • Uncertainty in income. If you expect a pay hike or pay cut in the near future, that can change your borrowing ability as well as impact your ability to pay a mortgage.
  • Got bad credit? Creating a history of on-time rental payments can help you build the sort of credit you need to qualify for a mortgage.
  • No maintenance. When the pipe leaks under the sink, you don’t head to Home Depot, you head for the telephone and call the landlord.
  • Incidental expenses. The landlord pays for many utilities such as water, sewer, garbage, and in some cases heat and hot water as well.

There are upsides to buying a home:

  • Equity. When you pay rent, you don’t own anything. When you pay a mortgage, you increase your degree of ownership in your home with every payment. Also, you can borrow against your ownership (or equity) in the home to pay for major purchases, refinance your home at favorable rates, or, once you’ve paid the entire mortgage off, borrow to fund major purchases like a second home or your child’s education.
  • Tax deductions. You can deduct mortgage interest as well as your property taxes. Uncle Sam doesn’t give renters this bonus. Not only that, but if you meet certain requirements the IRS won’t apply a “capital gains” tax on your profits from the sale of your home. You can keep the first $250,000 in profit you make when selling the home if you’re single, or the first $500,000 if married. In addition, those who work from home may be eligible to take deductions for their home office and portions of utilities.
  • Creative control. So, you like dozens of pictures on the wall? Well, hammer away—they are your walls now. Go ahead and paint them mango. Wish you had another room? Go ahead and add one.
  • Maintenance choices. If you live in a house, you can decide how to approach maintenance, either doing it yourself or picking your own contractor. If you live in a condominium or homeowners’ association, you may pay a monthly fee to have maintenance work covered by the association’s contractors.

While a home is a good investment—and let’s face it, you have to live somewhere—many financial experts caution against purchasing a home simply as an investment. Historically, the real estate market increases have been slow and steady, not meteoric (until recently). The stock market, on the other hand, has generated returns of between 8 and 10 percent pretty steadily for decades.

That depends on your market and where you choose to live. And consider whether or not you like to do maintenance. Homes cost money. Appliances break, roofs leak, and you are the lucky soul who gets to pay the bill. If you are renting, landlords pay the plumber and water/sewer and garbage bill to go along with it.

But, of course, there is that tax break. Depending on your tax bracket, a first-time purchaser’s 1040 tax deductions heavily subsidize housing expenses in the first few years. Since a 30-year fixed mortgage requires high interest payments—all deductible—at the beginning of the loan, you deduct a larger share of the mortgage cost early in the life of the loan.

Qualifying for a mortgage

A basic truth: A mortgage loan holds your house and land as collateral.

In most cases, a lender does not really want to end up with your house. They want you to succeed and make those monthly payments that make the world (or at least the U.S. world) go ’round. So when you apply for a loan, the lender will scrutinize your financial situation to make sure you are worth the risk.

You need to get your paperwork in order before you find a lender, but first you should understand the basic facts.

  • Down payment. Traditionally, lenders like a down payment that is 20 percent of the value of the home. However, there are many types of mortgages that require less. Beware, though: If you are putting less down, your lender will scrutinize you even more. Why? Because the less you have invested in the home, the less you have to lose by just walking away from the loan. If you cannot put 20 percent down, your lender will require private mortgage insurance (PMI) to protect himself from losses. (However, if you can only afford, for example, 5 percent down, but have good credit, you can still get a loan.
  • LTV. Lenders look at the Loan to Value (LTV) when underwriting the loan. Divide your loan amount by the home’s appraised value to come up with the LTV. For example, if your loan is $70,000, and the home you are buying is appraised at $100,000, your LTV is 70%. The 30 percent down payment makes that a fairly low LTV. But even if your LTV is 95 percent you can still get a loan, most likely for a higher interest rate.
  • Debt ratios. There are two debt-to-income ratios that you need to consider. First, look at your housing ratio (sometimes called the “front-end ratio”); this is your anticipated monthly house payment plus other costs of home ownership (e.g., condo fees, etc.). Divide that amount by your gross monthly income. That gives you one part of what you need. The other is the debt ratio (or “back-end ratio”). Take all your monthly installment or revolving debt (e.g., credit cards, student loans, alimony, child support) in addition to your housing expenses. Divide that by your gross income as well. Now you have your debt ratios: Generally, it should be no more than 28 percent of your gross monthly income for the front ratio, and 36 percent for the back, but the guidelines vary widely. A high income borrower might be able to have ratios closer to 40 percent and 50 percent.
  • Credit report. A lender will run a credit report on you; this record of your credit history will result in a score. Your lender will probably look at three credit scoring models, they will use the median score of the three for qualifying purposes. The higher the score, the better the chance the borrower will pay off the loan. What’s a good score? Well, FICO (acronym for Fair Isaac Corporation, the company that invented the model) is usually the standard; scores range from 350-850. FICO’s median score is 723, and 680 and over is generally the minimum score for getting “A” credit loans. Lenders treat the scores in different ways, but in general the higher the score, the better interest rate you’ll be offered.
  • Automated Underwriting System. The days when a lender would sit down with you to go over your loan are over. Today you can find out if you qualify for a loan quickly via an automated underwriting system, a software program that looks at things like your credit score and debt ratios. Most lenders use an AUS to pre-approve a borrower. You still need to provide some information, but the system takes your word for most of it. Later on, you’ll have to provide more proof that what you gave the AUS is correct.

Mortgage credit scores

Your credit report is separate from your credit score, though the score is developed from the report. In addition to viewing credit reports from the three major reporting bureaus, you also should obtain your FICO score. Your score is like a report card. Fair Isaac & Co. (the FICO score keeper) assigns you a number based on the information in your credit report. Since there are three credit-reporting bureaus, you have three FICO scores. Here are the scoring factors.

  • Payment history: Have you paid your bills on time?
  • Amounts owed: What is your overall debt?
  • Length of credit history: How long have you been borrowing money? Lenders like to see a long credit history.
  • New credit: Have you applied for new credit?
  • Types of credit used: Lenders like to see all kinds of credit types: bank cards, car loans, student loans, and more.

The FICO scores range from 350 to 850; an 850 is the Holy Grail of credit scores and 723 is the median score in the U.S., but you can expect good mortgage interest rates at the 720 to 760 level and up.

For anecdotal evidence of your good credit standing, if you notice you are receiving a lot of zero percent credit card or lines of credit offers, you are probably in pretty good shape.

Homebuyers who pursue an FHA loan, one of the most common loan types for first-time purchasers, can usually secure a loan if their credit is 620 or over.

Seventy to 80 percent of mortgage lenders use FICO as their means of determining your interest rate and the types of loan you qualify for; as interest rates creep up, this difference can be significant.

The good news is that your credit report is easy to get. A federal regulation that went into effect in September 2005 gives consumers access to one free credit report per year from each of the three reporting bureaus: Equifax, Experian, and TransUnion. The online report is generated after you answer a series of security questions and only takes about 10 minutes to complete.

How do you know what a good score is and what a bad score is? Well, that’s sort of a gray area since different scores are calculated in different ways; different creditors use different scores, and no one knows exactly how they are calculated since those formulas are proprietary to the companies using them. Scores may range from around 300 to 900 with the average credit score in America being at about 740. Here is an approximate range of how credit scores are judged:

  • Excellent credit: 720 and above
  • Good credit: 660 to 719
  • Fair credit: 620 to 659
  • Poor / bad credit: 619 and below

How credit reports affect your mortgage

Before you start house hunting and getting pre-approved for a home loan, check your credit report and get your FICO scores. Why? Your credit rating may be the single most important piece of financial information you have to obtain a mortgage at the best interest rate.

Checking your credit rating before you purchase will give you time to correct reporting errors and to clean up your ratings if they are in the dumps. One lender tells us that it can take up to 90 days to get erroneous — and costly — information off your report, although some prospective borrowers say they have a much quicker outcome.

Credit reports are a history of your track record of borrowing and repaying banks, credit card companies, and any other lenders. When you apply to borrow money, the lender uses the credit report to decide if you are a safe bet, or a risk. They also base whatever interest rate they offer on that report and the resulting credit score.

A credit report includes:

  • Credit history. This includes account information detail, such as your payment history, and specifically information about accounts that may have been sent to debt collection agencies. It also includes the number of accounts you have and the type of each, and if you are in good standing with each.
  • Who is examining your credit. Any inquiries by lenders or others about your credit is recorded as well.
  • Any judgments against you, such as bankruptcy.
  • Personal information about you, such as your addresses (current and past), Social Security number and your previous employers.
  • A section for comments by you, in the event you have disputed the report specifics in the past.

There are three major credit-reporting agencies: Equifax, TransUnion, and Experian. You can receive a free copy of your credit report once a year from, which gets the reports from each of the three companies.

It is a good idea to get a copy annually so that you can check it for errors. Errors range anywhere from name misspellings and incorrect Social Security numbers to accounts being listed as still open when in fact they have been closed—an error that can hurt you when you need to get a mortgage.

Your credit report also will show whether you have been the victim of identity theft. If your personal information, such as your Social Security number, has been changed, the report will reveal it.

When to buy

Buying a house has never been more affordable. Low prices coupled with record low mortgage rates have made purchasing a primary residence, second home or investment property very appealing. However the decision to buy a house is also a very personal one.

Personal factors that may influence your decision to buy:

  • You want to put down roots in a particular area.
  • You need more space for your stuff or your family.
  • You’ve had a change in your family such as getting married or having a baby.
  • You need a change in environment. Seniors might want to move to a place with fewer stairs; apartment dwellers might want to move to a detached home.
  • You want a place for your pet such as a big backyard for the dog.
  • You want to personalize and possibly upgrade features in your living space.
  • You want better access to things that matter to you (restaurants, schools, public transportation, hiking trails, etc.).

In addition to personal factors, it is also suggested that you consider whether your work and financial situations are stable. Evaluate whether you have:

  • A steady work history.
  • Steady or increasing income.
  • A good credit score.
  • Enough savings for a down payment.
  • Low overall debt.