Spring is here and house shopping is underway. Exciting, anxious and traumatic are a few emotions for the first-time homebuyer. There are expectations and requirements well as acronyms and terms that are brand new to our vocabulary. There are ARM’s, fixed and variable, LIBOR and Prime, 15 and 30 and a host of other topics that are downright intimidating.
The newest requirement for shopping for a home appears to be the pre-approval letter from the bank. Many sellers and realtors require you can prove you can buy the home you want to look at before they invest their time in you. The pre-approval comes from your financial institution and you essentially go through the process of getting a loan before you find your house!
The creditors will look at your gross income less your contractually obligated debts – car loans, minimum payments on credit cards, student debt, etc. – to find a ratio of debt-to-income. As an example, if you make $4,000 a month and have $1,000 of obligated contract payments, your debt-to-income ratio is 25%. The banks often want you to be less than 40% and though I didn’t understand it as a youngster I certainly get their logic now!
If you made the $4,000 monthly and looked to a 38% ratio, your total obligations could add up to $1,520 a month. That leads to an available house payment of $520 a month and must also cover the insurance and property taxes. A $100,000 house with 20% down would have a monthly payment of $405 not counting property taxes and insurance.
The two biggest issues that we see stopping people from getting home loans are the debt-to-income ratio and having the down payment. When student loans kick in that have been delayed, you can find perfectly good borrowers stuck in multi-housing rental units. The recent uptick of multi-unit housing is likely attributed to this issue. The way to counter the issue is to either put more down on the home thus reducing the payments and the risk to the lender or paying down other debts.
The down payment can be reduced in exchange for an insurance policy call private mortgage insurance or PMI. Your financial institution will tell you how much they require in order to avoid paying PMI. Some banks are at 20% and in the mid 2000’s some institutions didn’t require it at all. Notice how that worked out!
When young couples marry they may be of similar income and similar debt but often times that is not the case. You may find yourself in a situation where one spouse’s debt load (usually due to student loans or credit cards) is so great that you are better off to apply for the loan individually. The bank will always want as many signatures as it can get for car loans, credit cards and houses. This is where good thinking and planning can really help! However, there is nothing wrong with a mortgage being in one spouses name if they can qualify alone.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.