Before the lender agrees to give you the money, you need to meet certain standards that determine if you qualify for a mortgage loan, and if so, how much. At times, it may seem as though the lender is waving a magic wand in coming up with its determinations, but the truth is that established rules and formulas exist to guide the lender in determining the potential creditworthiness of an applicant.
The decision on your home mortgage loan is based on several basic factors, including:
The Dodd-Frank Act of 2010 mandated increased scrutiny for certain mortgage loans, particularly those for the self-employed and jumbo loans where debt coverage exceeds 43% of monthly income. Some mortgage loans will likely require more documentation and discussion.
The integrated disclosure rules for the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA) are collectively known as TRID. These disclosures must be delivered three days prior to loan closing and include a Good Faith Estimate (GFE) of closing costs. Deviations from estimated closing costs may result in refunds of excess costs and penalties to the lending institution.
Consumer Financial Protection Bureau
The Consumer Financial Protection Bureau (CFPB) was created by the Dodd-Frank Act to protect consumers from predatory or unfair lending practices. For example, the CFPB enacted the following:
The first thing you need to know about is something called your "debt ratio."
Lenders typically follow two general "rules of thumb" in determining how much mortgage you can afford based on your level of income and your existing debt payments. In today's environment, reliance on these ratios is not quite as rigid as it once was, but it remains the "first cut" in estimating how much a bank or credit union is willing to lend you.
Let's take a look:
Sound confusing? You bet it does. Let's shed a little light on the subject by looking at an example.
Calculating Your Mortgage Debt Ratios
(1) Annual gross income
(2) Monthly gross income
(3) Car Payments
(4) Other loan payments*
(5) Credit card minimum monthly payments
(6) Other fixed payments (e.g., alimony)
(7) Total monthly debt payments (add 3, 4, 5, 6)
*Include installment debt payments, student loans, and other loans
Using these example numbers, you would be able to afford a home and monthly mortgage payment that varies depending on the ratio and percentages used. Let's see:
You will note that the monthly mortgage amount ratios can give you significantly different numbers. It depends on the lender as to whether or not they use ratio 1 or the more restrictive ratio 2 in computing how much they feel you can handle each month.
What Does All This Mean to You?
Since lenders are using these guidelines to evaluate what you can afford and how much they will lend you, you should use them to get a ballpark figure of how much home you can buy and how much mortgage you can handle. Looking at homes can be very time consuming and frustrating. By calculating your price range in advance, you can narrow your search to those homes that you can afford, letting you find the home that's right for you a lot sooner.
SUGGESTION: Some lenders will calculate your mortgage debt ratios and offer you a pre-purchase loan commitment before you buy your home. Having this "pre-approved" status eliminates that uncertainty for the seller and makes you a more attractive buyer. This gives you additional buying power when negotiating the purchase price of your potential home.