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Finding the right financial solution for your real estate transaction can be confusing at times. It is important for you to know the facts about your mortgage before you buy a house. Making sure that you know how much you can afford and the best rates for your purchase can save you more than money, it can save you time and stress! Read the articles on this site to learn more. Make sure you use our Loan Calculators to take the first step to financing your home purchase.
Home Mortgage Basics
Please read this booklet that will help you learn a great deal about the mortgage funding process! (331 KB, PDF, Adobe Acrobat required). As always, if you have any questions, please feel free to call us, we're here to help!
Home Mortgage Qualification: Income, Credit, Equity, and Documentation.
The major qualifying factors for a home mortgage are Income, Credit, and Equity, commonly referred to as "ICE". The “big three” items will determine the types of home mortgage programs for which you qualify, and your eligible home mortgage rate. Your ICE mix plays a crucial role toward home mortgage options.
For instance, you can have a relative low income with a 10% or less equity interest in your home, mixed with a high credit score. This will qualify you for multiple home mortgage options at competitive mortgage rates.
Taking a closer look at the components of ICE, we'll examine its effect on home mortgage loans and mortgage rates.
Income
Your gross monthly income and housing expenses are used to compute an important qualifying ratio called the "Debt to Income" ratio.
Two calculations are computed. First up is the Front Ratio, which is your housing expense-to-income ratio. It is computed by taking your proposed mortgage payment (principal, interest, taxes and insurance- PITI) and dividing that number by your gross monthly income.
Second up is the Back Ratio, or your TOTAL monthly obligations-to-income ratio. To compute, take your total monthly payment obligations, including your proposed Mortgage PITI and divide that number by your gross monthly income.
Total monthly obligation expenses should be derived by adding all monthly expenses from your credit report, i.e.: auto payments, credit card payments, etc .... add to this, your monthly property taxes, monthly homeowner's insurance, and proposed new monthly mortgage payment to result in your total monthly obligation expense.
For many years, a debt-to-income ratio needed to be at .28 or lower for the Front Ratio, and .36 or lower for the Back Ratio in order to qualify for a conforming home mortgage (28/36). Conforming home mortgage programs will now allow higher qualifying Back and Front Ratios, sometimes as high as in the .40's for Front Ratio and into the .50's for the Back Ratio.
Higher debt-to-income ratio qualification will be dependent on other outside borrower factors, such as the credit report, Loan-to-Value ratio, and the specific home mortgage program underwriting guidelines. If you fall into DTI ratios in the .40's or even .50's, it never hurts to have your lender run your specific scenario through an Automated Underwriting System to see if you will be pre-approved with higher than standard debt ratios.
Conforming home loans usually have the best home mortgage rates, so it will be a few minutes of your time well spent!
Subprime lenders carry home mortgage programs that allow up to a .55 Back End DTI, but don't get too excited. Subprime lenders are falling fast and even their underwriting guidelines are getting stricter by the day.
FHA home mortgage loans are qualified with a high-end Front/Back DTI of .31 and .43 (31/43). Don't lose hope if your ratios are higher, because just like conventional lenders, FHA will allow higher Back and Front End Ratios. Of course, this will depend on your credit report, Loan-to-Value ratio, and other factors. Again, have your lender run your numbers though the FHA Automated Underwriting System, before you lose hope of qualifying. Higher than standard debt ratios are often approved.
An FHA home mortgage offers excellent rates for borrowers with high loan-to-value and low credit scores.
Home Loan Income Documentation
Full Doc Home Mortgage: Typical required documents are W-2's and tax returns. Fully documented home mortgages result in the best mortgage rates, and is the most popular home loan choice for borrowers.
Full Doc Refinancing - W-2 Wage Earners: W-2 wage earners are required to have a two-year work history, with no gaps in employment for more than 30 days, and in the same line of work for those that changed employment.
Hourly workers are capped at their base hourly pay, but overtime income is included if verified by employer that it will continue for the next 12 months. As for yearly bonus income, employers must verify it will continue for at least 2 years.
Other common additions toward gross income are items such as SSI, Alimony, and Child Support. Supporting documentation supporting a continuance of these payments for a minimum of three years will be required to include toward gross income.
Full Doc Home Mortgage - Self-Employed: Those self-employed are required to have been in business for a minimum of two years. Allowable income is determined by the bottom line number on your federal tax return AFTER all the Deductions. Some items are allowed to be added back, such as depreciation and amortization.
Common self employed documentation requirements:
- Sole Proprietorship: 2 years 1040's with all schedules.
- General Partnership: 2 years 1040's with all schedules, 2 years 1065's (partnership returns), and Schedule K-1.
- Limited Partnership: 2 years 1040's with all schedules and Schedule K-1.
- Corporation (IRS 1120): 2 years 1040's with all schedules, 2 years W-2's from corporation, and 2 years 1120's (corporate returns)
- S Corporation (IRS 1120S): 2 years 1040's with all schedules, 2 years 1120's (S corporation returns), Schedule K-1.
*** A YTD profit and loss schedule may also be required depending upon lender and whether the loan application is dated within 120 days of the end of the borrower's business tax year.
Stated Income Home Mortgage: Normal tax return business deductions and write-offs can make it difficult for a self-employed individual to qualify for a fully documented home mortgage. Those individuals have the option to "state' their income, providing they meet minimum credit score standards and loan-to-value ratios. Credit scores will need to be above 680 and loan-to-value ratios should not exceed 90% in most cases. Lender guidelines are getting stricter by the day for stated income home mortgage qualification.
Proof of self-employment can be shown with a CPA letter or DBA (“Doing Business As” form).
A stated income home mortgage will carry a higher rate of interest than a full doc loan.
No or Low Doc Home Mortgage: Those that prefer not to have their complete financial information presented to the home mortgage lender may like the No Doc or Low Doc home mortgage option. The least amount of information is required for a No Documentation home mortgage. Sometimes, only your social security number and property information is required.
With No Ratio home mortgage programs, the home mortgage lender will exclude your debt to income (DTI) ratio.
For NINA home mortgage loans (No Income No Asset), income and assets are excluded for qualification, but employment is verified.
Reduced documentation refinance loans will require a minimum credit score of 680-720 in most cases, and may also cap the amount of equity you can borrow against your home's appraised value to between 80% and 95%, depending upon the specific home loan program.
Mortgage rates will be higher compared to a Full-Doc home loan.
*** No Doc and Low Doc home mortgage options are fading fast as lenders further tighten their underwriting guidelines.
Credit
Home mortgage lenders rely heavily on credit scores for home loan qualification, and mortgage rates options for the borrower. Your "Mid" FICO score is used for qualification purposes. This is your middle FICO score between the three major credit reporting agencies: Experian, Trans Union, and Equifax.
Credit reporting agencies use such factors as credit mix, credit balances relative to total credit limits, any missed and or payments, judgments, collections, and the age of credit accounts to determine your score. Scores can range from 300 to 850. Higher scores qualify for more home mortgage options and better mortgage rates.
Equity: Home Mortgage Loan-to-Value Ratio
The amount of equity in your home is equal to the appraised value of your home, minus what you owe on your existing first mortgage and second mortgage (if you hold a second mortgage). Example: Home has an appraised value of $200,000 and you owe $120,000 on your first mortgage. $200,000 minus $120,000 results in a $80,000 equity interest.
The "Loan-to-Value Ratio” (LTV), determines qualification for home mortgage programs and mortgage rates. Better mortgage rates will result from a lower LTV. Divide the total loan amount by the appraised value of your home to determine the LTV percentage. Example: Total loan amount is $250,000. The appraised home value is $200,000. The resulting LTV is 80% (200,000 divided by 250,000).
Higher LTV's bring more risk for the home mortgage lender, resulting in higher mortgage rates with less qualified program options available.
Equity: Home Mortgage Value and Appraisal
Home Value is a major determining factor for home mortgage qualification and loan program options. How to find a Home's Value?
Many free online home valuation sites are available to give an estimate of the value of most homes. Zillow.com is a popular and easy to use free site that many use to get an idea of home value. However, online home value estimates do not replace the need for a lender approved home appraisal. The home appraisal protects both the lender, and the borrower from inflated and unrealistic home values.
Home Mortgage Appraisal Factors
Many factors are utilized in determining the appraised value of your home. Appraisers use the location of the home, proximity to desirable schools and other public facilities, lot size, size and condition of the home, and recent sales prices of comparable properties, among other factors.
Recent sales price of comparable properties is the biggest factor. Home mortgage lenders will require at least 3 comparables within a mile or two from the subject property. Appraisers may use a radius of up to five miles if there are not enough comparable homes in close proximity.
Home Appraisal Cost: Appraisals generally cost between $300 and $400, depending on location and the appraiser. Properties valued at over $500,000 usually have a higher appraisal cost.
