A basic truth: A loan holds your house and land as collateral; it’s not pound of flesh, but the loss can seem just as life-threatening.
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 5-20 percent of the value of the home. However, there are many types of mortgages that require less, like the FHA loan that requires 3.5% 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, and even avoid paying PMI. Ask your lender how.
- 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 homeownership (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 (one for home equity loans or lines of credit) and then average them to arrive at your score. 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.
Other Useful Information and Links
- Qualifying for a Mortgage
- Choosing a Mortgage Lender
- Mortgage checklist
- What to ask a mortgage lender
- Mortgage Types & Rates
- Private Mortgage Insurance
- Mortgage Rates Fearbusters
- Buying Vs. Renting
- Understanding Mortgage Credit Scores
- Debt to Income Ratios (what are they)
- Loan to Value Ratio
- What does a Title Co. do?
- Credit Report Tips, Finding Mortgage with Bad Credit
- What is an FHA Loan?
- Bad Credit Mortgage Solutions, Fixing Credit
- Credit Scores and Reports, Mortgage Rates
- Down Payment How much do you need to save
- Mortgage Glossary