Whether you’re applying for a mortgage for the first time or are looking at purchasing a new home and will be increasing your mortgage amount, it’s essential to understand how much you can afford. You may think that any number that fits within your monthly budget is comfortable and sustainable, but your mortgage lender may say otherwise. In order to determine what you can truly afford, there are some guidelines that mortgage lenders insist you abide by and they can ensure that you don’t get in over your head with your home purchase.

How Mortgage Debt Ratios Determine Affordability

You might think that if you make $4,000 per month that $2,000 per month to carry your mortgage is quite affordable but it’s not quite as simple as that to a mortgage lender. What they look at is a few essential debt ratios that ensure you’re taking on a mortgage well within your means with consideration to your other debts and expenses.

Gross Debt Service Ratio (GDS)

The gross debt service ratio looks specifically at the affordability of your housing costs, and it requires that they are not higher than a fixed percentage of your household income, which can vary by program and lender.

The way the GDS is determined is by calculating the monthly mortgage amount + property taxes + condo fees, and then that sum is divided by monthly income. In the case of the $4,000 income and the $2,000 mortgage payment, with this equation, that is not an amount that a mortgage lender would provide a borrower as the ratio is far too high without even considering the other housing costs.

Total Debt Service Ratio (TDS)

Your total debt service ratio is also considered to ensure that you get a mortgage amount that is easily affordable. The same calculation for the TDS applies, but with this debt ratio, all debt obligations are considered whether it’s a car loan, student loan or minimum credit card payments for outstanding balances as well as your housing expenses. This debt ratio can be no higher than 40%-42% on some programs, but this number can vary by program and lender.

Ensuring Your Mortgage is Always Affordable

While it may seem as though the mortgage amount that you’re approved for based on the debt ratios is much lower than what you believe fits into your budget, this is a realistic amount for a number of reasons:

• As a general rule, having your total debt expenses total no more than 40% ensures you have enough cashflow for savings, investments, household repairs, day-to-day living expenses and more.
• When you take on a fixed rate mortgage for 2 or more years, there’s potential that in that time period your situation or income could change. With a GDS of 32% or under, it’s more realistic to expect that if that happens, it’s more likely you’ll be able to continue to pay your bills.
• You never want to become house poor or you’ll begin to resent your investment. When you don’t over-spend on your home, you’ll still have opportunity to live your life.
• When you first buy your home, you may have fewer expenses than you would if your life changes. For example, when you make your purchase you may only be a couple and if later you have children, your variable expenses may change greatly.

The Mortgage Application Process

1. Discuss your needs and your finances with your mortgage professional - While this is not a step that you are required to take, even before you begin shopping for a house or a mortgage, it’s a good idea to go over your finances with a mortgage representative that can provide further advice on saving for your down payment or which debts you may want to pay off in order to qualify for the mortgage amount you’re hoping for.

2. Get Pre-Approved - Before you begin shopping for a house, you want to get pre-approved so you know what your lender will allow you to spend. In order to do this, you will need to need to complete a basic mortgage application and provide information about your income, debts and expenses.  Your mortgage professional will look at all of this information and will advise you on the best mortgages for your needs, and provide a guideline as to how much you can spend on your home.

3. Commit To a Mortgage - The specific process depends upon your lender, but typically once you’ve made an offer on your home, you will have to provide a few further details about you that way your mortgage application can be formally processed. You will receive a mortgage commitment, but there may be some conditions attached.

4. Fulfilling Your Mortgage Conditions - It depends upon your state and lender, but often you will be asked to prove that you have your down payment and even some of your closing costs in place 30 days before you’re set to close on your  home.  If some of your down payment will be coming from a family member as a gift, you may also be asked to provide a gift letter. Your lender wants to ensure that you aren’t borrowing your cash assets that you’re using for your home purchase.

5. Sign Your Closing Papers - This may happen before your closing date or on your closing date depending upon your lender and where you live.  You will then confirm the frequency of your mortgage payments and arrange a payment method for your mortgage premiums.

The above outlines some of the main components of the mortgage application process, though some of the finer details will depend upon your lender and the state you live in!

BuildFax bills itself as a “a one-stop shop for building, remodel, and repair information for over 70 million U.S. properties”.

From the BuildFax Website:

BuildFax collects and organizes construction records on millions of properties from cities and counties across the United States. Once in our system, we analyze, mine and compare the data so that it becomes like a “background check” on a property. We have data on new construction, major systems repair, additions, renovations, roofs, pools, demolitions, contractors and more.”

BuildFax’s database of permit information from building departments covers in excess of 4,000 cities and counties. BuildFax provides summary reports showing major renovations or repairs done on properties including additions, plumbing, air conditioning, roof replacements, etc. BuildFax reports also including contractor and dates of work completed.

BuildFax reports are usually $39.99 per report, but you can sign up for a FREE REPORT until July 31, 2011.

The first thing to note is that a bank takes your Gross Debt Ratio and Total Debt Ratio into consideration when determining how much money they will lend you.

Theoretically, you can afford to spend what you’ve been pre-approved for, but there are some other things you should think about when determining if you want to spend it all.

Determining How Much of Your Mortgage Approval Amount to Spend

While you may be tempted to spend your full pre-approval amount to get the best home available to you, there are some other things that you should consider when you take a look at your total expenses:

1. Would you need to make cutbacks? – Even if your full mortgage amount is under 40% in your total debt ratio, there are many other expenses not calculated by the bank. Take a look at all of your other fixed and variable expenses and determine if you’d need to make cutbacks to live comfortably with that mortgage amount. Remember, your expenses can include things like your grocery bill, the cost of children’s activities, and eating out.

2. Are you willing to change your lifestyle? – If you would need to make cutbacks to spend the full mortgage amount, take a look at what you would be willing to give up, if anything. For some, it may be worth the sacrifice to get a “better” home. For others, it may be preferable to spend less on the home and maintain status quo in other aspects of life.

3. Are your expenses likely to change? - Remember, your pre-approval amount is based on your current income level and debts. It might be affordable today, but if you have intentions to leave your job or take on new expenses, the affordability may change quickly.

Once you’ve considered all of the above factors, it’s up to you to determine how much you’re comfortable spending. Don’t feel pressure to spend it all, but if that number is a comfortable one, then getting shopping for a property of that value!

How Will Your Job Change Impact Your Mortgage Loan?

You need to bring your potential job change to the attention of your mortgage lender and there are a few factors they’ll look at to determine if that may compromise your ability to take on the mortgage you were previously approved for:

• If your income level will remain the same at your new job. If it’s higher, your mortgage may not be impacted; if it’s lower, it has the potential to change what you can afford.
• If you’ll be working in the same industry as the job(s) you’ve held before. Your mortgage lender may consider it a risky move and it could potentially compromise your mortgage.
• If there’s going to be a probationary period at your new job that will still be in place when you close, because then the chances are much greater that you’ll lose it since there’s zero job security.
• The length of time that you’ll be at your new job before your mortgage closing date. If you’ve switched jobs 90 days before you close on your home, then you may have enough stability on your side.
• Whether your high ratio mortgage is insured or backed up by a program or grant. Guidelines may differ, but some programs that allow you to make a low or no down payment  on your mortgage may choose to run a credit report and revisit your file at any time. You need to tell your lender or mortgage broker about your job change, and if this other program looks into it and don’t like what they see, they could refuse to back your loan.
• Your loan approval amount. If you’ve got a home loan that’s far less than what you can afford (according to the bank’s assessment) and are a two income household, it may be that your loan approval would not change.
• Your debt ratios. Regardless, your lender would recalculate your Gross Debt Ratio and Total Debt Ratio based on your new income, or based on the other household income if yours for some reason cannot be used.

Keep in mind that everyone has different circumstances and there can be compensating factors, so before you decline or accept a job offer, we can help give you guidance so that you can make an informed decision.

What is Escrow?

The escrow process puts your money in the hands of a neutral third party to complete part of the necessary financial process for you to close upon your home. An escrow account is required by many lenders in order to ensure that you’re prepared to cover some of your home expenses once you take posession as this protects their investment.

What is the Escrow Process?

Typically, an escrow account is opened before you actually close upon your newly purchased home and at that time you are required to start adding funds to it. Typically, the costs you will need to place into an escrow account is the insurance, property taxes and sometimes the utilities. Here is the general escrow process:

1. Around closing, your mortgage lender may require you to deposit the payments to cover at least one month’s worth of funding for the required expenses. Often, lenders ask for 2-3 months of payments.
2. Your money will be protected with the third party that holds onto your money as they transfer it only to the lender for the pre-determined expenses on a set schedule.
3. Once you take posession of the home you will be making flat rate monthly payments to cover your expenses (property taxes, insurance, utilities) and the lender will use the funds to pay the appropriate outlets directly. Many first time home buyers find this especially simple because it helps them manage their money. Typically, property taxes would be paid on a quarterly basis in a larger lump sum. Paying monthly into escrow means that smaller amounts of money are automatically removed from a home owner’s account, so the process is budget-friendly!

Understanding what you’ll be responsible for paying for in cash is good information to have before you even submit a mortgage application. The specific costs can vary depending upon the state that you live in, the cost of your home and to other factors, but here are some basic things to consider that should be considered.

Down Payment Required for a Mortgage

In order to qualify for a mortgage, you will likely have to produce a down payment. The specific amount required for a down payment depends upon state guidelines as well as the type of loan. FHA mortgage loans offer the competitive down payment options for those who qualify, requiring under 3.5% of the purchase price down.

Mortgage Closing Costs

In addition to requiring money for your mortgage down payment, you’ll need to save money for closing costs. This is something that you may be able to get paid by the seller of your new home, but as this is not something that is guaranteed, it is wise to have some money on hand to pay for all of the costs of purchasing a home that cannot be rolled into your mortgage. If you present a mortgage lender an offer that does not include closing costs covered by the seller, often as a first time home buyer, you are required to prove that you have the money to cover them. Depending on your local market environment and location, 3% to 6% of the purchase price may be a fair estimate for your closing costs, and somewhere in this range is what a mortgage lender will typically need to confirm.

Target Purchase Price and Other Considerations

Since the location, cost and your unique financial and credit attributes can affect what you will need to put down when you purchase a home, we can help you better understand the estimated amount that you’ll need to pay when buying a home. More importantly,  we can help you understand and target the home purchase price that suits your specific needs an finances so you can be prepared in advance to make your first home purchase!

1) If it is a bank foreclosure asking you to qualify through their bank, They are requiring this because:

A) They want one of their people to check you out to make sure you are really qualified.  Sadly, a large percentage of  pre qualification or pre approval letters are not worth the paper they are typed on.  Some lenders do not even run credit before they say you are pre approved! 

B) They want an opportunity to get your loan business.  Banks make money off of each loan they close.

C) If the bank approves you and you go with another lender and the loan “blows up” you can go back to the bank and they can close the loan for you.  Remember they already approved you.

2) It it is a foreclosure asking you to get a 2nd approval through their preferred lender.  This means that the foreclosing entity and lender are not in the same company.

A) They want a lender they trust to go through your file to make sure you have the ability to close the purchase because of reasons mentioned in 1A

B) They make absolutely no additional money if you use their preferred lender.  They do get peace of mind which can be priceless.

C) They know if their preferred lender does the loan it will close.  If you use another lender and it “blows up.” you can go back to the preferred lender to close the deal and rescue the deal.

D)  Certain financing is available on certain types of foreclosures.  Very few lenders take the time to learn “niche” loans which is another reason you will see a preferred lender.  The preferred lender knows how to do the unique financing.

Note:Due to the complicated nature of financing these days we are seeing preferred lenders on both short sales  and regular sales now too.

Lenders’ perspective:  I am fine with the 2nd approval process.  I am happy to call the other loan agent and see what they need and get it over to them as quickly as possible.  It is the nature of our business right now. Also, they are providing a complimentary service for my client. They are providing options.   I am always suspect of lenders that dislike this process.  It is really not that much extra work. It makes me wonder why they do not want their clients to have additional options.

Expect:
1) An emotional yet controlled recovery: 
The emotional aspect:  If you read the business section you can see the view on the recovery swing rapidly from day to day.  On Monday we are recovering and on Tuesday the market is being hailed as the next big depression.  On Wednesday everything is sunshine and rainbows and on Thursday we are doomed.  There is a lack on consistency in mood.  This is what we call an emotional recovery.  Every speck of data is sending the media and emotional investors to the extreme on each side. It is manic depressive to say the least.

You can take advantage of this by investing when they say it is the end of the world.  It is amazing some of the deals on solid companies that have been offered up in the last 36 months due to doomsday news. It is a great time to start saving for retirement or increasing your retirement savings.   Rates also will go up and down with the news. Quick cheat sheet below
Great Depression = lower rates    Recovery= higher rates

The Control Factor:  This recovery is being controlled and pushed along by the government and the “powers that be.”  Look at the housing issue.  Our country cannot afford to let the foreclosures all hit the market at once. There are just too many.  This happened in 2008 and it devastated home values and threw the economy into the dump.  Since the 2008 free for all, there has been a much more controlled release of foreclosures.  Between the attempts at modifying, moratoriums and behind the scenes deals we have been seeing foreclosures come out in a low controlled movement.  Expect this to continue. The flood of 2008 will not happen again. It will be the trickle of 2011,2012,2013 and 2014.  I say no to the double dip.

2) The Year of the Short sale:
Short sales are speeding up a little bit which is great but what is even greater is that in the past few months we have seen more and more buyers  actually wanting to buy a short sale.  In the past people were hesitant due to all the unknowns involved.  However, short sales in many cases are now priced more aggressively than foreclosures, there is more short sale inventory and lenders are more willing to approve them. Also, there is new legislation in CA that makes it more attractive for homeowners to short sale their homes.

3) Lending to loosen a bit:  We are starting to see the beginning of slightly looser lending. Debt ratios are not loosening up but some of the documentation is. Stated is still a far way from coming back although there are some hard money sources offering stated income as long as there are assets.  We are starting to see more products coming into the market and more investors wanting to do local deals that are unique.  A big part of our 2011 plan is trying to say yes twice as much as we say no.  
4) Modifications to remain problematic:  The way in which modifications are being handled is so poor that I have absolutely no hope that it will be fixed by the end of 2011.  For example, I was reviewing a friends credit report who was going through a modification and even  though they had made their modification payment every month on time their credit history showed 7 lates due to partial payments (the modification payment).  Their score had dropped from 780 to 540.  They did everything right and their credit was hit harder than if they had done a short sale.  Bank of America is being sued by a few states over their modification processs and their have been countless stories of modifications gone bad.  The bottom line is that the servicers make more money by foreclosing or a short sale than they do by modifying. Until this is changed expect modifications to remain useless for the masses.

5) Foreclosures are here to stay:  There will not be a flood but the trickle will continue.  There will continue to be some great foreclosure deals.

For buyers and investors 2011 will be a year filled with opportunity.  For everyone hoping they can gain equity to refinance their house we are still a few years off. I do still hope that a no equity refinance will be introduced but I am not holding my breath.