Once you have determined that buying is the correct move, and once you have decided on what payment you would be comfortable with each month, it’s time to contact several lenders to re-assure that you in fact will be able to qualify for a loan. That re-assurance comes in the form of either a pre-qualification or a pre-approval letter. An initial pre-qualification or pre-approval allows a buyer to have an idea of the total mortgage cost and applicable monthly payments. To pre-qualify a buyer, a lender uses income and expense figures provided by the borrower. A credit report rarely gets checked at pre-qualification; at times, the lender will simply perform a light search with basic data. In contrast to the educated, yet tentative nod given in a pre-qualification, a pre-approval provides a firm lender decision after a longer applicant analysis, along with a commitment to lend the borrower the money needed. Pre-approvals ordinarily have a time limit. Obtaining a pre-approval before searching for properties allows potential buyers to also demonstrate proof of purchasing power when making an offer. After pre-approving a client, a mortgage lender presents the best available loan packages tailored for the borrower along with an estimate of monthly mortgage payments, based on the anticipated purchase amount. The lender is required to provide a Good Faith Estimate, which shows how much the buyer can borrow together with the costs associated with the loan. If the purchase is a cash purchase, you will need to obtain a Letter of Qualification from your financial institution, stating that you have the necessary funds (specific amount should be shown on the letter – equal to the amount of your projected purchase) to complete the purchase.
Note that nowhere in this guide has “selecting an agent” been mentioned yet, for a reason. It is vital to first determine what you would be able to realistically afford, and what payment you would be comfortable with, before plunging into a search for properties that may well be outside your realm or comfort level. It would be wasteful to both the agent and you! You can certainly contact real estate agents from the on-set to help guide you as to what you would be looking at in terms of purchase price, but refrain from jumping into a property hunt solely based on assumptions. Most agents will tell you to get at least a pre-approval letter, however some, believe it or not, will actually show properties, only to later find out that they are outside of your realm. First, determine what price range you need to stay within, then tackle the search!
When evaluating loans, lenders consider two ratios: front-end and back-end. The front-end is your mortgage payment, plus taxes and insurance, divided by your monthly salary. It signifies the payment a buyer could reasonably afford, from a lender’s point of view. You may prefer a lower payment. The front-end ratio for an FHA loan is 31%. For a conforming conventional loan, the front-end ratio is generally around 33%. This means if your monthly gross income is $4,000, to qualify for the maximum FHA loan, your monthly principal, interest, taxes and insurance (PITI) payment can not exceed $1,240. For a conventional loan, it would be $1,320.
The back-end ratio adds your monthly debt payments to your PITI payment before dividing that total figure by your salary. It’s higher than the front-end ratio, for an FHA loan about 43%, a conforming conventional loan about 45%. This means if your car payment is $300, and you pay $100 a month between two credit cards, your total monthly recurring debt is $400. On the FHA loan payment above of $1,240 PITI, plus $400 recurring debt, your total would amount to $1,640. The back-end ratio number is $1,720 ($4,000 x 43% = $1,720). Your total debt is less than $1,720, so you would most likely qualify. In the case of a conventional loan, $4,000 x 45% (back-end ratio), equals $1,800. The total debt of $400, plus your new mortgage payment of $1,320 for a conventional loan equals $1,720. Since the total debt is less than $1,800, you would also most likely qualify for a conventional loan. A 50% debt ratio is a high ratio. A high debt ratio means that you may not qualify for a loan. If you should find an unscrupulous lender that is willing to fund such a loan, you may not be able to afford to feed yourself, even if you were to eat dirt!
