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Thursday, April 27, 2006

50 Year Mortgage

Statewide Bancorp of Rancho Cucamonga is now offering a 50 year mortgage. Over the past several years many lenders have been steering borrowers towards a 40 year mortgage rather than interest only loans, but this takes that one step further. Borrowers looking to reduce their monthly payment and buy a bigger house can now squeeze out an extra few hundred dollars a month.

From the article:
For a 30-year loan of $300,000 at 6.5 percent, principal and interest cost $1,896.20 per month. A 50-year loan for the same amount and at the same rate costs $1,691.15 per month in principal and interest. The 50-year loan costs $205 less per month, but the payments stretch out for 20 years longer and will cost a total of $332,058 more.

That extra cost is hard to ignore, but given California's inflated housing market it might be attractive to some people.

Tuesday, April 25, 2006

How Much House Can I Afford?

A common question from borrowers is how much house can they qualify for. The answer to this question takes some work since there are a number of variables that must be accounted for. Interest rates, down payment size and lender DTI restrictions all play an important part.

To start with, let's assume an income of $60,000, or $5,000 per month. To simply things we will assume that there is no other monthly debt. I will show how to take other debt into account as we go along.

The maximum allowable DTI (debt to income) ratio varies from lender to lender, with some sub prime lenders allowing as high as 50-55%. For conforming loans the standard is 36%, so we will use that in our example. A DTI of 36% means that your mortgage payment can be as high as 36% of your $5,000 income, or $1,800. If you have other monthly debt you will need to subtract that from this number. What is left is your maximum monthly mortgage payment.

To turn a monthly payment into a loan amount we need two things: interest rate and loan term. To maximize buying power you want the term as long as possible. Normally this is 30 years, though many lenders now offer some sort of 40 year product. Since a 30 year term is the most common and is available from any lender we will use that in our calculations. For an interest rate we can check the going rate for a 30 year fixed product, which at the time of this writing is about 6%. This rate will definitely change based on creditworthiness, so adjust it up or down based on your credit.

The formula for loan amount from a monthly payment is the inverse of the formula for monthly payment from loan amount that we looked at last time:

Payment = Loan Amount * ((I)(1+I)^N) / (((1+I)^N) - 1)

Loan Amount = Payment * (((1+I)^N) - 1) / ((I)(1+I)^N)

Recall that I is the interest rate per payment period as a decimal and N is the number of payments.

For the numbers we chose above we get:

Loan Amount = 1,800 * ((1.005^360) - 1) / ((.005)(1.005)^360)
Loan Amount = 1,800 * 5.02257 / (.005)(6.02257)
Loan Amount = $300,224.85

The final step is to factor in the size of the down payment. You can do this in two ways, depending on how much money you have on hand. If you have a set amount, such as $30,000, that you have set aside for your down payment, then simply add this to the loan amount and you have your maximum house price. If you have enough money to specify a percent down payment, such as 10%, then divide your loan amount by the LTV (100 - down payment %). For the numbers in our example this is $300,244.85 / .9 = $333,583.17.

As you can see we are forced to make some assumptions, such as the interest rate and allowable DTI, but once we do this we are able to get a reasonable estimate as to how much house you can afford (or at least qualify for).

Monday, April 24, 2006

Monthly Payment Calculation

In this post I will explain how to calculate what your monthly payment will be for a specific mortgage. For this calculation we need three numbers: the loan amount, the loan term and the interest rate.

LA = Loan Amount
I = Interest rate per payment period. Take the yearly rate as a decimal (6% = 0.06) and divide that by 12 for a monthly payment, or 24 for a semi-monthly payment (0.06/12 = .005)
N = Number of payment periods. Multiply the length of the loan in years by 12 for monthly payments or 24 for semi-monthly.

We can then use these numbers in the following equation:

Payment = LA * ((I)(1+I)^N) / (((1+I)^N) - 1)

Here is an example for a $100,000 loan for 30 years at 6% interest with payments made monthly:

Payment = 100,000 * ((.005)(1.005)^360) / ((1.005^360) - 1)
Payment = 100,000 * (.005)(6.02257) /5.02257
Payment = $599.55

From this calculation you can also find the total amount that you will pay over the life of the mortgage. In this case take the monthly payment and multiply by the total number of payments ($599.55 * 360 = $215,838). You can see that borrowing $100,000 at 6% will end up costing you $115,838 in interest over the 30 year life of the loan. However, at the end of the loan your house should be worth much more than at the start. An annual growth rate of 2.6% over the 30 years yields a final value of just under $216,000, which would offset the cost of the credit.

Wednesday, April 19, 2006

FICO Rules!

When a lender checks your credit report they receive one or more credit scores. These come from three main credit score vendors and are based on a proprietary statistical model. They are often collectively known in the industry as FICO score, after Fair Isaac and Company, which is one model.

Vendors normally receive up to three scores, ranging between 450 and 850. The most common rule used by underwriters is the middle of three scores, lesser of two, and the one if only one is returned. Some lenders require at least two scores. When there is more than one borrower on the loan the score used is normally that of the primary wage earner.

The credit score is used by the lender as a measure of risk. Lower credit scores have experienced more credit problems, or have less experience with debt. As FICO goes down, the rate goes up and the maximum allowable loan amount and LTV come down.

Most states have rules that allow you one free credit report every year, or if a certain number of credit inquiries or transactions occur. Checking your credit report for errors or fraud can help you prevent identity theft, keep your credit clean, and help you qualify for a bigger mortgage at a better rate.

You don't normally see your credit score on a credit report, but if a mortgage broker or loan officer pulls your credit you can usually ask them to tell you what your scores are.

Wednesday, April 12, 2006

Insider Tip: Low or No Doc Mortgage

Sometimes taking a "Low" or No Doc mortgage makes sense even if you are able to provide full income documentation. Stated income or no income verification can allow more non-traditional income count towards qualifying for a mortgage.

Suppose the amount you want to borrow would cause you to have a payment that would give you a Debt To Income (DTI) ratio above the standard allowable 36%. If you choose to use a No Doc option you could claim a higher income, thereby reducing your DTI. Since No Doc loans carry higher interest rates your payments will be higher and so will your actual DTI.

Your actual income is $2000 per month, and you've found a Full Doc loan with a payment of $750 per month. This would give you a DTI ratio of $750/$2000 = 37.5%, which is above the normal limit. If you were to do a No Doc loan instead and claim an income of $2500 per month you would reduce your DTI to below 36%, as long as the rate increase did not make the monthly payment exceed 36% of $2500, or $900. Your actual DTI would be $900/$2000 = 45% (or less if the payment is lower).

Using this strategy you can borrow more money than you would otherwise be able to. However, you will pay more every month. Mortgage lenders are not blind to the fact that this is going on, and they charge a steep premium for No Doc loans (which they sometimes call Liar's Loans). The maximum LTV is also normally restricted to 80-90%, and often property types such as investment are not eligible. Specifics vary by lender.

Tuesday, April 11, 2006

Basic Terminology: Documentation Type

Most mortgage loans require that the borrower provide some type of documentation of their income and assets. There a several levels of documentation that are acceptable, and each has a different potential impact on the loan. Available doc types vary by lender, but the most common are Full, Limited, Stated and No Doc.

Full documentation usually means that the borrower is required to provide two years of W2s or tax returns, full details of employment, and verification of any mortgage or rental activity for the same period. Full doc loans are the most common and don't incur any special rate increases or additional qualification restrictions.

Limited documentation loans are generally based on bank statements rather than W2s or tax returns, and are designed to help self-employed or 1099 employees better document their earnings. Limited documentation loans are held to tighter standards than full doc loans, with common restrictions including lower maximum LTV and allowing only owner-occupied properties. In addition, limited doc loans have a higher interest rate than a similar full doc loan.

Stated income is used when a borrower prefers not to provide the documentation required to prove their income. This can be useful in cases where borrowers don't have regular wages or there are privacy concerns. The stated income will need to be reasonable for the borrower's line of work, and employment is usually verified for the past two years. Stated doc loans have even more restrictive qualification guidelines than limited doc, and often carry a higher interest rate.

No doc loans are available, though they are very restrictive. Only borrowers with nearly perfect credit reports are able to qualify. These loans carry a large interest rate hike to offset the lender's greater risk. Many lenders do not do no doc loans, and the vast majority of those that do are sub-prime.

In general the more documentation that you are willing and able to provide the easier it will be to get a mortgage loan and the more options that will be available. The interest rate almost always goes up steeply as doc type goes down.

Monday, April 10, 2006

Basic Terminology: Debt To Income (DTI)

I previously mentioned the LTV ratio as one way lenders judge risk when underwriting a mortgage loan. Another number that is often used is the Debt To Income ratio or DTI. The DTI is the percentage of a borrower's monthly income that goes toward paying their debt. The more debt a borrower has the more likely that they will have trouble paying their mortgage and eventually default on the loan.

There are two types of debt ratios that mortgage lenders generally use: front-end and back-end. The front-end ratio looks only at the payments on the new mortgage, while the back-end ratio looks at all of the borrower's debt. Debts such as personal and auto loans, credit cards, alimony and child support, and other mortgages are considered in the back-end ratio. Bills such as utilities and gym memberships are not generally considered. The rule of thumb is that if a debt has an interest rate associated with it then it is considered in the debt ratio. The debt's minimum payment is used to determine the monthly amount. The front-end ratio is also known as the housing ratio, while the back-end ratio is typically just referred to as DTI.

You have found a new mortgage loan that looks attractive and that has a payment of $1000 per month. In addition you have a minimum monthly credit card bill of $150 and a $300 car payment. If your salary is $4000 per month then your front-end ratio would be $1000/$4000 = 25% and your back-end ratio would be $1450/$4000 = 36.25%.

Different lenders have different guidelines about how high these two ratios can be. Most lenders typically allow a DTI of 36% for conforming loans and up to 50% for non-conforming loans. The Federal Housing Administration (FHA) has guidelines of 29% for the front-ratio and 41% for the back ratio. If your new loan would cause you to exceed the lender's limits then they won't approve the loan.

Debt consolidation, or using part of your mortgage proceeds to pay off your other debts, can often result in a lower DTI and allow you to qualify for the loan.

Friday, April 07, 2006

Basic Terminology: Occupancy Type

Another term that is used quite often in the mortgage industry is Occupancy Type or Usage Type. In general there are three ways in which a subject property may be classified based on how the owner intends to use the property: Primary Residence, Second Home and Investment.

If the borrower lives in the house on a daily basis it is their primary residence, while if they live there less than a given number of days each year than it is considered a second home. If the borrower intends to rent the property it is considered an investment. Rental income is normally more important than whether the borrower spends any time at the property, so a vacation home that is occasionally rented out will probably be considered an investment property.

Second homes and investment properties are somewhat more risky to lend on than primary residences, so rate increases for these property types are common.

Thursday, April 06, 2006

Basic Terminology: Loan To Value (LTV)

One of the primary ways that mortgage lenders evaluate the risk associated with a potential loan is by looking at the Loan To Value (LTV) ratio. This number is determined by dividing the requested loan amount by the value of the mortgaged property. The higher the ratio the less equity the borrower will have in the house at the beginning of the loan.

Here is an example:
You wish to purchase a new house for $100,000, and you want to contribute 10% as your down payment. This means you need a loan for the remaining $90,000. The LTV ratio would be 90,000/100,000 = .9 or 90 percent. LTV is usually quoted as a percent.

LTVs on new loans typically vary between 80 and 100 for purchases, and between 60 and 100 for refinances. Higher LTVs mean that the borrower is borrowering more money and has less personally invested in the property. This is important to the lenders because they see a borrower with a small investment as more willing to lose that investment by not paying their bills and having the house foreclosed upon than someone with more invested and more to lose. The increased risk that the lender is taking is offset (in their minds at least) by charging a higher interest rate for higher LTVs.

Unfortunately, if you were to keep a 30 year mortgage for its entire term and you started out with a high LTV, you would end up paying much more overall because of the higher interest rate than you would if you refinanced the mortgage once you had built 10 to 20 percent equity.

Wednesday, April 05, 2006

Mortgage Secrets from an Industry Insider

Welcome to my new site. I'd like to share my insider knowledge of the mortgage industry and help people interested in consolidating loans, refinancing mortgages and general mortgage advice. In the future I'd like to post answers to questions posed by my readers, state specific information, plus general tips and information about rates and lenders.

I've been working for the last 6 years to help automate the underwriting processes at many of the major lenders, including Wells Fargo, Genworth (GE) Mortgage Insurance, America's Money Line and many others. During that time I have picked up a good deal of information about how the mortgage industry works and how to get the best loan for any given situation.

My specialty is so-called "sub-prime" loans, where the borrower's credit is not so good. Bankruptcies, foreclosures, judgments, charge offs etc. None of these has to stand between you and your new mortgage, and I can tell you how.