There many alternatives to
consider when selecting a mortgage for your new home.
Most lenders link the amount of the mortgage they'll offer to two key
credit evaluation ratios. The first is the monthly housing cost-to-income
ratio. As a general rule, conventional lenders will require that your
monthly mortgage payment (consisting of principal, interest, taxes, and
insurance (PITI)), and any other related fees (condominium assessments,
etc.) not exceed 25 to 28 percent of your gross monthly income.
On certain types of loans,
such as fixed-rate mortgages that require a large down payment, lenders
will increase this to 33 percent. However the 25 to 28 percent housing
cost standard is used for most conventional (non-FHA or non-VA) loans.
FHA and VA lenders use different qualifying criteria. The FHA, for
instance, allows your "housing costs" (including PITI, utilities, and
maintenance) to equal 29 percent of your gross monthly income.
The second item that
lenders focus on is your total monthly debt, including your new monthly
house payment and all other installment-type debts, such as car loans,
revolving charge accounts, and personal debts. The general rule of thumb
is that your total installment debt should not exceed 33 to 38 percent of
your gross monthly income.
You will find that the
FHA and VA measure the ratios somewhat differently from conventional
lenders. The ultimate result is that there is a limit on the size of the
loan any lender will grant you.
history on all types of previous debt will be evaluated. The better this
history is, the more comfortable the lender will be with a larger loan.
Possessions and assets:
include everything from bank accounts to autos and stocks.
as length of employment, steady growth in rank and earnings, and potential
for additional earnings, (salary increases, commissions, or bonuses, etc.)
will be taken into account.
also consider the expected closing or settlement charges on the loan.
These are usually expressed as a percentage of the mortgage amount. If
you don't have the ability to pay all related fees, the maximum loan
amount for which you qualify may be reduced.
More House for the Money:
Certain mortgages can increase your buying dollar. Most of these
mortgages are structured to keep your monthly payments low for the first
few years of your mortgage. Because your initial debt is lowered, you
qualify for a larger loan amount.
The most popular are
adjustable-rate mortgages (ARMs). ARM's can often put you in a more
expensive home on your current income than can a traditional fixed-rate
The monthly payment on an
ARM can vary throughout the term of the mortgage, with certain
limitations. Their first change can occur when the introductory rate
period runs out. Depending on the ARM you choose, the first rate
adjustment could jump by two percentage points or more.
Check out the
annual and life-of-loan rate adjustment caps.
They are commonly two and six percentage points, respectively. That
means that in any given rate-adjustment period on an ARM, the rate could
rise no more than two percentage points. Over the entire life of the
mortgage, it could rise no more than six points.
worst case scenario before choosing an ARM.
If the rate on your mortgage were to rise to 15%, could you handle the
Be sure you
understand how the future rates will be affected.
Does the index, (the standard your ARM is tied to) rise and fall
dramatically (like short-term U.S. Treasury note), or does it move more
slowly (like the cost-of-funds index)? Is the margin (the amount added
to the index to cover the lenders cost and profit) high, or can you find
a lender that is charging less?
All these factors will
help you determine whether to maximize your mortgage power and buy a more
expensive house, or compromise and buy a little less house with more
conservative fixed-rate loan.
An alternative to an ARM is a buy-down on a fixed-rate mortgage.
Buy-downs are rate subsidies paid for by the seller or the borrower. For
example, a seller may offer you a 8 percent fixed-rate mortgage in a 10
percent fixed-rate market. To accomplish this, the seller will pay the
lender the 2% difference to subsidize the rate for the expected term of
the mortgage. Although the 8 percent rate may not be as low as that of an
ARM, many buyers prefer the buy-down because they know exactly how much
their payments are going to be over the life of the mortgage.
(GPMs) In the first year, you pay your lowest rate (say, 7 percent). In
the second year, the next step, your rate may jump to 8 percent. In year
three, the rate may rise to 9 percent, where it will remain for the term
of the loan. This process arranges the timing of your payments, keeping
them low in the early years to better enable you to qualify, then raising
them enough in later years to restore the unpaid interest during the early
Be aware of the
possibility of negative amortization in most GPM's. That means building
up greater debt to pay for the lower-rate years. For example, an $85,000
loan balance might increase to $90,000 before you begin to pay off the
principal on your mortgage. Negative amortization GPMs aren't for
everybody, but they can help you obtain more home with your present
DON'T GIVE UP
What if a lender rejects your application for a loan? It doesn't always
mean you cannot obtain a loan. It is possible that you are talking to the
wrong lender. Submit the same application on the same house to a lender
whose customer profile or underwriting standards are different, and you
may find a different result. Good luck!