Home Loan Housing Ratios
Mortgage lending institutions use several gauges to measure how much of a mortgage you can afford. Housing ratios is one such gauge that measures your capacity to deal with the monthly mortgage payment. These ratios are used to evaluate mortgage loans for home purchases and existing mortgage refinances.
Housing ratios are generally broken down into two distinct measures or ratios. The first housing ratio often referred to as the front-end ratio, measures the cost of your mortgage payment divided by your gross monthly income. The second ratio, referred to as the back end ratio, measures your mortgage payment with all other contractual monthly payments divided by your gross monthly income. Some banks and mortgage lenders separate the term housing ratio to mean just the house payment and the debt ratio to refer to all payments.
The front end ratio calculates the full PITI mortgage payment. The PITI is the principal and interest payment of the home loan, the monthly real estate taxes and monthly cost of homeowners insurance and/or mortgage insurance. The back end ratio adds to the PITI any other contractual debt. Examples of other debt would be; car loans, credit card payments, department store charge card payments, personal loans, and similar debt payments. Generally utilities bills and day care expenses are not included in the housing ratios. Also excluded are payments on installment loans the have 10 payments or less remaining.
Housing ratios on conventional mortgage loans are usually 32% for the front end ratio and 38% for the back end ratio. FHA loans are generally expected to be 29% for the front end and not to exceed 43% on the back end ratio. As you can tell from the description, ratios are generally set as guidelines not laws that have to be enforced. One can view the housing ratios as guideposts to which your expenses should not exceed. However, with compensating factors is possible to obtain approval for a home loan with excessive housing ratios.
Compensating factors are generally favorable features about your application they would be considered better or more desirable than the standards credit and income requirements. Examples of compensating factors might include; exceptionally good credit, financial assets above and beyond the necessary amount for the loan request, or a low loan to value ratio. If an FHA applicant had debt ratios of 30% and 45% but was putting a 25% down payment, this loan will most likely get approved rather easily.
The biggest problems in housing or debt ratios, other than an applicant having ratios that exceed the requirements, is the accurate calculation of monthly income. Income in the mortgage industry is measured is the gross or before tax income, calculated on a monthly basis. Part time jobs with less than two years are generally considered as income. Overtime income must be verified that it will continue and must be received for the past two years. All income that fluctuates significantly will usually be averaged over the previous two years.
Debt payments play a big factor in qualifications as well. If a mortgage applicant can reduce there monthly debt payments, it may be easier to get approved for a home loan. Obviously, reducing the debt itself is the clearest method. However, it is also most likely the most difficult. Almost any legitimate plan to reduce an applicant’s debt prior to applying for a home loan is acceptable. In some cases, if the primary borrower makes all the income but has an excessive debt load that ends up disqualifying them for a mortgage loan, there is a trick. Debt that can be pushed on to the spouse that is not cosigned by the primary borrower relieves that debt payment from the primary borrower. Since the spouse’s income is not used to qualify for the mortgage purchase or refinance, it is possible to leave the spouse off the home loan and qualify with the primary borrower with debt transferred onto an account of the non-qualifying spouse.
Housing ratios and debt ratios are general rules. Certain factors regarding qualifying for a loan will be hard and fast rules, not these ratios. These numbers should be a guidepost to give you a reasonable idea as to what you can afford. Be sure to check the mortgage rates when evaluating debt ratios since a higher mortgage rate means a higher mortgage payment and a greater debt ratio. The mortgage calculator can be very helpful for measuring debt ratios and the impact of different mortgage terms and mortgage rates.
Fair Lending Protection in Home Mortgages
When you apply for a mortgage loan to purchase a house, refinance, or for a second mortgage, there are two federal statues that protect you rights and curb abusive lending pertaining to discrimination. These two acts or statutes are the Equal Credit Opportunity Act and the Fair Housing Act. Many aspects of the rules and regulations of the two acts overlap. Congress intended to provide sufficient protection to homeowners and borrowers when cases of potential discriminatory practices arise.
The Fair Housing Act prohibits discrimination in housing based on race, national origin, religion, sex, familial status and handicap. Much of the act covers action in housing as it pertains to rentals and sales. The act also covers several aspects of discriminatory practices in mortgage lending. The main components covering prohibited lending practices based on race, color, national origin, sex, familial status, or handicap are:
Refusal to make a mortgage loan.
Refusal to provide information regarding available home loans.
Enforce different terms and lending conditions.
Discriminating regarding the appraisal of the property.
Refusal to purchase a home loan or set different terms for purchasing a home loan.
Advertise or make statements that indicate limitations or preferences based the protected classes.
Interfering with those who are exercising a fair housing right.
FHA prohibits discrimination in these specific cases but is also designed to cover almost all aspects of mortgage lending. Mortgage origination’s and mortgage lenders are covered under FHA as is appraising residential properties, the buying and selling of mortgages irregardless if the loan is to purchase, build, repair or make improvements to the residential property.
ECOA is primarily designed to cover credit transactions. ECOA bars discrimination in credit dealings based on race, religion, national origin, sex, marital status, age, income derived from public assistance, or a borrowers ability to exercise their rights under the Consumer Credit Protection Act.
If you apply for a bank mortgage and are turned down, remember that not all institutions have the same lending standards. Shop around for another mortgage lender or bank. If a lender does deny a mortgage loan or place an applicant in a high mortgage rate and high cost loan, it does not mean they have broken any federal laws. These companies are just predators exploiting the weakness of borrowers in need. But if the way you were treated suggests the possibility of unlawful discrimination, you may want to check with a local fair housing group, the state enforcement agency, the local branch of a federal enforcement agency or contact the Department of Housing and Urban Development at:
Office of Fair Housing & Equal Opportunity
Dept. of Housing and Urban Development
Washington, DC 20410-2000
1-800-424-8590
Automated Underwriting in Home Loans
After a home loan application is completed and submitted with the required supporting documents, it’s sent to the underwriting department for evaluation. Underwriting is the procedure of analyzing the risk and reward in a home loan file and weighs the applicants credit profile, income, assets, and property data. The process is designed to measure the applicant’s qualifications for a particular mortgage loan product. This process had been performed manually. An underwriter evaluated the decision on whether the risks of a particular loan applicant matched the rewards or guidelines for a loan individually. Automated underwriting has now supplanted most of the human element in the evaluation for mortgage loans that are used for purchases or refinances.
Automated underwriting is simply a computer algorithm that evaluates the data entered regarding a mortgage loan application and renders and approval decision. Automated underwriting facilitates the underwriting data collection and analysis. The foundation is a complex statistical model that the measures the basic components used in weighing mortgage lending risk and reward analysis. Factors on the mortgage loan amount relative to the value of home are weighed, the income and debt levels with the corresponding housing ratios are weighed and of course the credit profile. The major automated underwriting programs are Desktop Underwriter provided by the Federal National Mortgage Association and Loan Prospector provided by the Federal Home Loan Mortgage Corporation. Several independent mortgage lenders have established their own automated approval systems as well.
These automated underwriting systems, at their core, utilize measurements of numerical risk factors. A weighted factor on income is broken down into a numerical dollar amount. Job time is a number. Funds to close a purchase or financial assets in the bank are numbers. The credit report is evaluation of numbers on the amount of credit trade lines, the dollar balances owed, the amount that may be delinquent, the number of times delinquent. The creation of credit scoring models such as the FICO score greatly facilitated the ability to adopt automated models. The credit score gives a quantitative evaluation of a clients profile and makes computer analysis much easier. Some factors are measured as simply yes or no, which is quantified by the computer with a number value. Data entry and accuracy are extremely important. Ultimately, there is no subjective evaluation.
There are disadvantages of such a system. The ability to subjectively measure that a borrower is improving their position is difficult if not impossible to weigh. The ability to compensate for mitigating circumstance that cause a number entered to be artificially low is omitted. But, this approach has not only streamlined the data collection needs in the mortgage industry and thus expedited loan decisions but the system almost entirely eliminates unfairly biased decisions about gender, race and ethnic origin. Since the bias is eliminated, processing times are shortened and the amount of data needed is reduced, these models will only grow in use. If your home loan for a purchase or refinance is turned by an automated underwriting system, ask for the findings or results. Understand why it was denied and evaluate what it would take to change the input in order to get your home loan approved in the shortest time possible.
Risky Home Mortgages
Mortgages with risky terms or ones based on dicey credit standards are mortgages that can cause you problems. High risks mortgages may have an appropriate use in the mortgage marketplace for those borrowers who do not meet conforming guidelines. Borrowers who exhibit the needs of a high risk loan commonly needed a mortgage loan due to slow credit, extremely high loan amounts relative the homes value, or loans to speculate on real estate. In an earlier period, high risk loans were introduced to serve just this market segment. High risk loans were designed to relax the requirements for credit standards, little to no down payments and excessive debt ratios. Sub prime loans are the typical loan type we think of regarding high risk lending. As of recent, these loans have morphed and have now been used for a variety of purposes and sold to borrowers who don’t fall into a category of needing a home loan used for high risk transactions.
A mortgage is a loan that provides you with the resources to buy a home. If you aren’t educated about the types of loans that are available, some lenders may attempt to sell you a mortgage with lots of features and variations that don’t apply to your particular needs. There are many different products out there and some of them are dangerous. Make sure you know about high risk mortgages that can potentially get you in trouble. With slightly higher rates or conditions that are pushed onto the borrower, many lenders find offering these products more attractive for their overall rate of return.
Option ARM (adjustable rate mortgage) loans are probably the most dangerous type of mortgage. These loans give you a lot of flexibility when your monthly payment is due: pay a little or pay a lot. However, you can get in trouble very easily. Option ARM loans are mortgages that give a borrower a choice on how much a given payment is. This seems like a valuable feature inasmuch as you have the flexibility to respond to month to month circumstances. You can make a minimum payment, a full payment, or an interest only payment. These loans are filled with pitfalls.
First, you don’t build equity unless you make the full payments that you would make with a conventional mortgage. Given a choice between a large payment and a small payment, which one will you choose? With the smaller payments, you’ll actually owe more on your house at the end of the month than you did at the beginning, a situation of negative amortization.
Another peril of an Option ARM is that small payments will not last forever. Sooner or later the bank will want to put you back on schedule to pay the loan off, and will “recast” your loan at given intervals, or when you owe too much on the home (110% or 120%, for example) due to negative amortization. When they recast, they set the loan on track to fully amortize over its remaining life, and your minimum payment can increase sharply. If your budget can’t afford this increase, you’re in trouble.
An option ARM is almost always a bad idea. The mortgage rates on option ARM’s are initially a very low teaser mortgage rate. As soon as the introductory rate period or teaser rate is over the fully adjusted rate on this loan is as high as a 30 year fixed rate loan. Sometimes, the fully adjusted rate is distinctly higher than a 30 year fixed rate. If the introductory rate lasted a reasonable length of time, the low initial rate may have some value. The problem with the option ARM is that this teaser rate expires anywhere from one month to six months. The option ARM is clearly one of the worst loan products that were sold on a wide scale and in the category of Arms has the least favorable terms.
Interest only loans give you the ability to pay less each month because you’re not repaying principal. You can set up your own amortization schedule, that is, a schedule for paying back principal. However, you can also end up without any equity in your home – and possibly have to write a check if your home loses value and you want to sell it. Interest only loans should be used by the most disciplined of borrowers. The interest only option allows for a lower payment but, the principal has to be paid back at sometime. Delaying the repayment based on estimates of future home appreciation or the ability to refinance at a later date under more favorable terms may be a gamble that can cost you your home.
The home loan programs that have yielded some of the biggest problems this year are the no income verification loans and the various permutations of them. Alt-A, no income, no doc, and stated income are all terms to describe similar loan programs. These loan types don’t require the borrower to document their income. For the self-employed borrower who would employ aggressive techniques for write offs against their revenue stream or income, these loans filled a need. Recently, the use of low document income loans or no document income loans were used for wage earners and borrowers who had income that would have been easily verified. These mortgage loans may allow a borrower to qualify for a loan that under normal underwriting guidelines would have been impossible. The risk and cost for the borrower is now trying to figure out how to make the monthly payment on a loan based on income that they did not actually earn. Foreclosure figures on this loan type are certainly proving that not verifying income is not a free ride to homeownership.
Many of these loans have in fact opened the door for increased number of borrowers to become homeowners. Some of these home loan products may be appropriate for you. If you’re thinking of using one of these loans make sure you understand the risks. Don’t be tempted by the reassurances of a mortgage lender that profits at your risk. It may make more sense to buy a less expensive house with a fixed rate mortgage or repair your damaged credit first. Do your research and comparison shop before making the leap.
Avoid Over Paying Mortgage Junk Fees
Additional fees for obtaining a home mortgage that serve no useful purpose are called junk fees. Most fees associated with originating your loan are third party fees necessary to obtain a loan approval, examples are appraisal fee, credit report fee and flood certification fee. Fees that are not necessary and are paid directly to the originating mortgage company are junk fees. Most junk fees do have one main purpose – increase the profits of the firm arranging the loan in addition to the money that make on the mortgage rate.
In order to ascertain which fees are junk and potentially profiting the originator at your expense, you have to compare the costs of the loan. One of the biggest obstacles in obtaining the least expensive loan is being able to accurately compare loan quotes. A mortgage rate quote by itself is of little value. You need the interest rate, term, costs and loan program. Clearly there is no point in comparing the rate and cost of an adjustable rate loan to a fixed rate loan with different terms. Before you attack the junk fees and question the loan officer, evaluate the different loan products and then get a mortgage rate quote with a complete break down of costs.
When you’re going through the process of applying for the loan, you will be given a variety of documents. Mandatory disclosure documents that are given out with every mortgage application make the evaluation exercise much simpler. One such document is the Good Faith Estimate that covers all the costs associated with obtaining the home loan. Federal law requires all mortgage lending institutions to provide a good faith estimate of closing costs within 3 days of the borrower filling out an application. With the Good Faith Estimate you should also receive a truth in lending notice. This is another federally mandated disclosure that spells out the mortgage interest rate over the life of the loan. These two disclosure documents, combined, are the key to evaluating the home loan fees and costs.
On the Good Faith Estimate form the costs of the loan will be itemized by category. Some lenders will charge more than others in various categories. The category of the fee is often not as important as the total amount of the fees. As an example, if lender A charges a $400.00 processing fee and lender B does not, lender A is not necessarily the better deal if lender A charges a $1000.00 origination fee and lender B charges no origination fee. Compare total costs and groups of costs as opposed to focusing on any particular fee that jumps out as being a junk fee.
The first group of fees on a Good Faith Estimate is the fees to cover the lender or originating mortgage lender for their services. This group is the category of fees with the greatest amount of room for negotiation. Here you find the charges for origination fee, discount points, appraisal fee, credit report fee, processing fee, document preparation fee, underwriting fee and perhaps other related charges. Junk fees are almost always thrown into this group. The key is compare similar loans with more than one mortgage lender. The total fees are more important than how any lender breaks them apart.
The second group is the prepaid charges. There is really no room to overcharge here, so negotiating should be irrelevant. On a purchase, the homeowners insurance may go here and the interim interest for the time you have the loan until the start of the first payment cycle would be disclosed here.
The third group is reserve or escrow deposits. These deposits are dictated by the taxing authorities and the time of the closing. Escrow are fairly well regulated, it would be difficult to find abuse in this section.
The fourth section is the title and closing charges. It is not often you will find a mortgage company that will negotiate the title charges. The primary reason being that the title company or closing company is not related to the mortgage company in most cases. If the title company is related, negotiate this fee as low as possible. Even if they are unrelated, it never hurts to complain about the amount of the charges for title insurance and closing fees.
Even though negotiating and asking questions about the closing costs can be time-consuming, you may be able to save hundreds, or even thousands of dollars at closing. Get another rate quote if necessary from a competing mortgage company. Compare the figures. Ask if the fees can be reduced. Don’t be intimidated; there are an abundance of mortgage companies looking for your business. If the loan officer won’t help you, move on and find one that will. Asking for the best mortgage rate and best terms at the lowest cost is your right.
When you get to the closing make sure the fees that were explained to you at the time of the application and placed in writing on the good faith estimate are equivalent. The purpose of the good faith document is to let you know what loan fees that you may be paying at closing. At the closing you will receive a HUD-1 settlement statement to review and sign, be sure the fees on this document are the same as the fees in the good faith estimate. If you want to question any of the fees on the HUD-1 settlement statement, do it without delay. You may feel as if you shouldn’t question these fees, but you have a right to do so and you should understand all aspects of this process with its cost.
Shop wise. Don’t accept the first offer that comes your way. Closing costs are necessary evils of closing a mortgage for either a home purchase or refinance. However, at times, they are used to increase the income of the mortgage originator or lender in a deceptive manner. It’s the job of a good loan officer to explain all of the costs to you and expect that you may shop around. A good loan officer who does his or her job right should expect that of educated borrower and accept the competition. Any amount of money that you can save at closing will be worth it.
Home Mortgage Right of Rescission
Under the Truth in Lending Act, the right of rescission is a protection that is given to borrowers that are obtaining certain types of loans. This gives the borrower the right to cancel within three working days of signing the documents for the loan. They can also get a full refund of any funds that have already been paid. The right of rescission is designed to give you the three days to reconsider whether you want the loan in question, which uses your home as collateral. You may have reconsidered a refinance or a home improvement loan that uses your home as collateral, or may have decided to look for other loan options, for example. This three-day period is often called a cooling-off period, and gives you a chance to decide if the loan is what was expected and what you really want to do.
The right of rescission applies to certain types of loans. For example, a refinance with a new lender or a cash-out refinance, in which you are taking money out that is greater than your current mortgage for whatever purposes. It doesn’t apply in every case where you use your home as collateral on a loan. For example, you can’t use a right of rescission on a loan which is used to build or purchase your primary home, when a creditor for your loan is a state agency, or if you refinance or consolidate with your current mortgage lender without borrowing additional funds. The right applies to your primary residence only. It applies regardless of the type of residence; single family home, 2 units, mobile home, condominium or townhouse. It also applies to some installment loans, where a fixed amount is borrowed and the payments are made on a schedule, or to a HELOC (home equity line of credit).
After you sign the loan documents, you have the right to cancel, or rescind the transaction until the third business day at midnight. Business days for the purpose of rescission do not include Sundays or public legal holidays, but they do include Saturdays. The day you sign the contract is considered to be the first day. A Truth in Lending disclosure form will be given to you, which informs you about important disclosure in the contract. The disclosures on the truth in lending form inform you about the credit terms such as the amount you have financed, the annual percentage rate, the finance charge, the payment schedule and the total number of payments. You are also given two copies of a right of rescission notice that explains your rescission rights.
While your transaction is in the three-day waiting period you won’t receive any funds from the loan until after this waiting period is over. If you use your right to rescind when mortgage refinancing and decide to cancel the transaction, you must provide written notice of cancellation to the lender. Be sure to follow the procedures outlined regarding your right of rescission carefully. Visiting the lender without putting something in writing or making a telephone call does not qualify. The lender is required to return any property or money that was given in connection with the loan within twenty calendar days after receiving your notice of rescission, and is required to make sure any action that is necessary to show that the termination of the security interest has been completed.
You can rescind the loan you sign within the three business day for whatever reason you choose as long as the loan type falls under the federal laws for having a right of rescission. During those three days after you sign for a loan, if you find better terms at another lender or change your mind, you may cancel or rescind the loan. All fees or costs to obtain the mortgage loan must be returned to you when you rescind a home loan.