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When you are ready to buy a home, most people realize that the first step in the process is obtaining financing for the purchase. After all, the amount that you are approved for ultimately determines which home you can buy. Many people begin by looking at numbers - the amount of their monthly income, how much of a down payment they can afford, and the approximate amount of the payments they can handle. However, there are three extremely important numbers to take into consideration first. Let's take a look at credit scores, loan to value ratio, and debt to income ratio and discuss why you should always look at these when you are starting your mortgage application.
Your Credit Score
Your credit score is basically a number that reflects how you handle credit. It gives lenders an idea of how "creditworthy" the borrower is. Scores can range from 300-850, and each person's score is calculated by using payment history, total credit available, and length of credit history. 35% of your score is based on payment history, with another 30% being based on the amount of credit currently being used. Length of credit history makes up 15%, 10% is new credit, and the remaining 10% is based on the type of credit being used. So why is a credit score important? First, it is the most important factor in determining the amount of interest that will be charged. The three credit bureaus, TransUnion, Equifax, and Experian calculate your score monthly. A score of 760 or better is considered excellent, and a person with this score will probably get the best interest rates available. If your score is 650 or lower, be prepared for higher interest rates. While a higher interest rate may not seem like much at first glance, over the life of the loan, it can add up significantly.
Loan to Value Ratio
This is a determination of the percentage of the loan value to the value of the home. It is an indicator of the amount of equity or the value of your home less the amount of money you still owe. Keep in mind that each monthly payment consists of two parts, principal and interest. For example, let's say you borrowed $200,000 to buy your home. If your monthly payment is approximately $1070.00, approximately $930.00 of that money will be applied to the interest, with the remainder being applied toward the principal. Many lenders have a minimum LTV that they use when determining the amount of an applicant's loan. This is important because it determines the down payment that will be needed in order to purchase a home. Suppose that on the $200,000 home purchase, the lender requires a 90% LTV. The borrower would have to pay a 10% down payment, or $20,000 for that home. Borrowers should be prepared to pay an additional monthly fee for mortgage insurance if they are not paying at least 20% for a down payment.
Debt to Income Ratio
As we all know, our mortgage is not the only bill that we pay each month, and lenders will want to ensure that each borrower can afford to make their payments. For example, we will say that a borrower's before-tax monthly income is $5000. The lender will take into consideration all monthly payments including car loans, credit card debt, student loans, utility bills, and other mandatory expenses, including the amount of the mortgage payment. Suppose that amount adds up to $2700. That amount divided by $5000 in monthly income is a DTI of 54%. Lenders look at the amount of the DTI when making a lending decision. Depending on the lender, the amount can be approximately 50% or less. Every lender has their own guidelines and circumstances that they examine.
Now you know the three most important numbers that lenders look at for mortgage applications! If you are purchasing or refinancing a home, or for more information, contact us today!
Please note, by refinancing your existing loan, your total finance charges may be higher over the life of the loan.