Understanding Debt-to-Income Ratio

Amount in versus amount out: You hear that all the time in relation to calories when you’re working on your physical health. Here’s a fun fact: it applies to your financial health, too — specifically when you’re applying for a mortgage loan. A mortgage lender will review your credit history, your assets, and your employment, but they’ll also look at your income vs. your expenses, otherwise known as your debt-to-income ratio, or DTI.

Consider this a “big picture” look at your finances. Lenders want to be sure you’re not living paycheck-to-paycheck, and that you can cover your mortgage as well as credit card debt, auto loans, child support and any other recurring monthly debt payments.

The percentage fluctuates, but generally the amount of money you spend on your mortgage and other debts should be no more than 43% of your total monthly pre-tax income. The actual percentage changes based on the type of loan, the sales price of the home, and the lender you choose.

To calculate your DTI, add up your recurring monthly expenses, including your proposed housing expenses, and divide by your monthly pre-tax income. If your housing expenses total $1,000, your car loan is $250 and your credit card averages $300 every month, you’d have expenses totaling about $1,550. If your pre-tax monthly paycheck is $3,750, that gives you a DTI of 41%. This is also known as the “back-end ratio.”

You may see DTI written as a fraction, such as 28/41. The second number is the back-end ratio. The first number is called the front-end ratio. This is the calculation of how much you spend on housing costs compared to your income. When making these calculations, it’s important to remember that your mortgage payment is not your sole housing expense; taxes, insurance, and other fees are part of this number. The most common limit today for a front-end ratio is 28%. FHA loans may allow a higher number.

A few years ago, during the housing boom, some lenders allowed DTIs up to 55% for nonconforming loans. These days, lenders are more wary about ensuring their borrowers are a good risk and unlikely to default on their debt. As credit requirements have risen, DTIs have dropped. So a borrower with a high credit score and low DTI will more easily secure a loan with favorable terms in today’s market. These days, your DTI may be just as important as your credit score when you are applying for a new home mortgage.

It’s important to remember that your DTI is not a true calculation of all your monthly expenses. It does not include food, clothing, fuel, and other such expenses.

So, just like a bodybuilder trying to bulk up, when you’re looking for a new home financing loan, the amount in (your income) should be greater than the amount out (your expenses).

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Dallas-Ft. Worth Home Prices Predicted to Rise 5.8% in 2012

Dallas-Fort Worth Home Prices to Rise 5.8% in 2012, Analyst predicts the first annual increase in Prices since 2007. Read more here

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Who Represents You?

In almost every state in the U.S., buyers have the option of being represented by their real estate agent. This relationship creates responsibilities that require the agent put their client’s interests above their own.

The duties a buyer or seller can expect to receive among others are honesty, accountability, full disclosure, representation and reasonable skill and care. In a nutshell, the agent who represents you is working in your best interest.

It’s a special relationship that doesn’t exist with most of the other professionals involved in a real estate transaction. Mortgage and title officers are limited to their duties of honesty, accountability and specific requirements under the Real Estate Settlement and Procedures Act.

This special relationship with your real estate agent makes it advantageous to have them coordinate your efforts with the other professionals in the home buying process. Since most buyers’ and sellers’ transactions are infrequent, the agent can bring valuable experiences to the transaction.

A Residential Finance Consultant is trained and has special tools to help you make better decisions when you buy or sell and in between. Our goal is to help you improve and maintain the investment in your home so we can earn the right to be your lifelong real estate professional.

Top 10 FHA Loan Advantages

Fannie Mae and Freddie Mac underwritten conventional, FHA and VA loans account for the vast majority of mortgages chosen by buyers to finance their home purchase. While buyers have the choice on which product to use, there are some considerable advantages to FHA.

1. More tolerant for credit challenges than conventional loans.
2. Lower down payments than conventional loans.
3. Broader qualifying ratios – total house payment with MIP can be up to 31% of borrower’s monthly gross income and total house payment with all recurring debt can be up to 43%.
4. Seller can contribute up to 6% of purchase price – this money must be specified in the contract and can be used to pay all or part of the buyer’s closing costs, pre-paid items and/or buy-down of the interest rate.
5. Self-employed may qualify with adequate documentation – two year’s tax returns and a current profit and loss statement would be required in addition to the normal qualifying and underwriting requirements.
6. Mortgage Insurance Premium can be released in five years when the balance is 78% of original sales price
7. Liberal use of gift monies – borrowers can receive a cash gift to assist in purchase from family members, buyer’s employer, close friend, labor union or charity. A gift letter will be required specifying that the gift does not have to be repaid.
8. Special 203(k) program for buying a home that needs capital improvements – requires a firm contractor’s bid attached to the contract specifying the work to be done. The home is appraised subject to the work being done. If approved, the home can close, the money for the improvements escrowed and paid when completed.
9. Loans are assumable at the existing interest rate – assumptions require buyer qualification but are actually easier than qualifying for a new mortgage. Closing costs are lower on assumptions than originating a new mortgage.
10. If the rate on the assumable mortgage is lower than current rates for new mortgages, it could add value to the property.

One More Chance?

Fixed Rate mortgages are at their lowest level for 2011 as reported in the current Freddie Mac weekly Primary Mortgage Market Survey. Many qualified buyers missed the opportunity last fall in October and November to refinance at record low rates. This may give homeowners one more chance to refinance and save money on their payments.

An important thing to keep in mind is that points paid in connection for refinancing a home are generally not considered prepaid interest and must be spread over the life of the mortgage. Some advisors suggest that you have the lender quote a “par value” loan to eliminate the points which will lower refinancing costs even though the mortgage rate will be slightly higher.

Additional income tax information is available in IRS Publication 936.

Equity is Forced Savings!

 

Equity is simply the difference in an owner’s unpaid balance and the value of their home.  Amortization and appreciation contribute to the equity over time.  The equity is usually realized when the home is sold but it can also be accessed by a home equity loan or a cash out refinance.

 

Most people think that it takes years to significantly pay down a mortgage and they’re partially correct.  A five percent interest rate on a mortgage takes approximately 20 years to pay down half of the original amount borrowed.

 

A mortgage is like a forced savings account because each payment is first applied to the interest due on the borrowed money but another part pays down the principal.  On a $188,175, 5%, 30 year mortgage, the first payment of $1,010.16 includes $226.10 principal reduction.  In the first year, the owner would have increased the equity in their home $2,776.24.

 

 

 

 

In the example below, the buyers paid $195,000 for a home that is estimated to appreciate only 1% per year for 7 years.  With a 3.5% down payment, the equity in the home at the end of 7 years would be $41,921.  55% of the equity would come from amortization; 29% would come from appreciation and 16% from the down payment.

 

 

Everything EXCEPT the Down Payment

It’s one thing to have the down payment and not qualify because of credit scores but in today’s tough financial environment, it may be even more frustrating to have good credit, income and job stability without the down payment.

The 2010 NAR National Housing Pulse Survey states that 79% of respondents identified the down payment and closing costs as obstacles to homeownership.  73% express a lack of confidence in getting approved based on a concern that banks have made it too hard to qualify for a home loan.

Most buyers depend on the savings or the proceeds from the sale of a previous primary residence for the down payment.  The savvy agent can recommend some other legitimate sources such as a gift from a relative or friend that doesn’t have to be repaid.

Another frequently overlooked source of down payments could be the buyer’s IRA.  If neither buyer has owned a home within two years, each may withdraw $10,000 from their own IRA to be used to buy a home.  The money must be applied within 120 days from the withdrawl.  The 10% penalty normally associated with early distributions is avoided but it will be subject to income tax since it was exempt the year it was deposited into the IRA.

Full disclosure of the source of the down payment needs to be made to the lender.

Sources of Down Payment First-Time and Repeat Buyers	All Buyers	First-Time	Repeat
Savings	66%	74%	57%
Proceeds from sale of primary residence	23%	1%	42%
Gift from a relative or friend	18%	27%	8%
Sale of stocks or bonds	7%	6%	8%
401k/pension fund including a loan	7%	8%	6%
Loan from a relative or friend	6%	9%	3%
Inheritance	4%	4%	3%
Individual Retirement Account	3%	3%	3%
Equity from primary residence buyer continues to own	2%	*	3%
Loan or financial assistance from source other than employer	2%	3%	1%
Loan from financial institution other than a mortgage	1%	2%	1%
Proceeds from sale of real estate other than primary residence	2%	*	2%
Loan or financial assistance through employer	1%	1%	*
Other	4%	5%	3%
National Association  of REALTORS® Profile of Home Buyers and Sellers 2010

Supersize a VA Loan

Since 2004, the maximum VA loan is the same as the maximum FNMA mortgage which is currently $417,000.  Occasionally, a Veteran wants a loan in excess of that amount.  If the Veteran will put a 25% down payment on the excess amount, a lender will loan the other 75%.

Example

Sales Price	$475,000
Maximum VA Loan	$417,000
Excess Amount	$58,000
25% Required Down Payment on Excess	$ 14,500
Adjusted Loan	$460,500

VA loans are eligible for veterans of the military with a certificate of eligibility.  A Veteran can get a 100% loan up to the maximum VA loan amount and the seller can pay their closing costs which would allow a Vet to get into a home with no down payment and no closing costs.  The VA Funding Fee can be rolled into the mortgage or paid by the Seller.

When the Vet sells the home, their VA loan is assumable at the existing interest rates but does require qualification of the new buyer.  The benefits would be a possible lower interest rate and lower closing costs.

There’s more to finding the “Right” home than driving around looking at houses.  A Residential Finance Consultant can help you make better decisions to help you understand the tax advantages, financing alternatives and investment aspects of homeownership.