We decided to sit down with a mortgage broker and get officially pre-qualified for a mortgage. Actually “officially pre-qualified” is an oxymoron because the whole process only involved a legal pad and a calculator. The following is just our experience, yours might vary significantly, I really don’t know.
If you’re not familiar with the terms, “pre-qualified” is just a very rough estimation of what kind of loan you can get from a lender. You tell them your credit score (roughly), your income, your debts, and your current assets. They don’t verify any of this, or run a credit check. It’s basically means nothing to a seller. On the other hand, a “pre-approval” is based on your actual credit score and verification of all your numbers (at least for a full-documentation loan). You need to submit tax returns, old W-2 forms, bank statements, paystubs – basically your entire financial life laid bare. This may offer an edge if a seller is comparing offers between you and another seller without a pre-approval.
Lender Ratios
But for me, the main reason for doing this is to find out what their lender ratios were. Also called the debt-to-income ratio, this is all your monthly liabilities (housing payments, car notes, credit card payments, student loan payments) divided by your gross income. This gives you the maximum debt load that the lender will accept and still lend you money. By housing payments, this usually means PITI, or principal + interest + taxes + insurance, so it’s a little more than just the straight payment from a mortgage calculator.
Also, historically, there were two lender ratios, at “top” and “bottom” value (Example: 28%/36%). The bottom (lower) number was the max ratio allowed for [housing] divided by [gross income]. The top (higher) number was the max ratio for [housing + other debt] divided by [gross income]. You had to be below both ratios to qualify for the loan. But I was told that if you have no other debt, that we can bump right up to the top value. I guess before they figured you had a good chance of adding on more “other debt” later in life, but now they just care about total debt load. So really there is only one ratio in many instances – the top one.
Historically, the top lending ratios were somewhere in the neighborhood of 38%. But I was surprised to hear that it’s more like 45-50% now in expensive areas like California, and he has seen as high as 60%! Keep in mind this is a percent of gross income before income taxes! 😯
A 5.75X Income Multiplier!?
Let’s say your gross income is $100,000/year ($8,333/month) and you manage to be clear of any other debts. (This is just for a round number.) Using this Mortgage Qualification Calculator, I plugged in zero down payment, the default property tax (1%) and insurance (0.5%) rate estimates, a 6% mortgage rate, and a 50/50 lender’s ratio. Here are my results:
I used zero down payment because I wanted to find out what the “income multiplier” was for lenders. In this case, I could theoretically get a loan for $575,000 based on a gross income of $100,000… 5.75 times gross income! And this doesn’t even take into account any down payment. If you had $100,000 to put down, you could technically buy a $675,000 house while earning $100,000 per year. And you wonder why housing prices went nuts…
Viewed another way, they would let me spend a total monthly payment of $4,166.67 towards housing. Using this paycheck estimator and using a Single person with one exemption living in California, the net monthly take-home pay each month would be $5,364.50. First, I’ll ignore the potential deductibility of mortgage interest, although it can be significant. That means $4,167 out of $5,364, or 78% of take-home pay, would be going towards housing. This leaves just 12% ($1,197) for everything else – food, utilities, gas, emergencies, retirement savings, whatever. Ouch!
2/3rds of Take-Home Going To The House
Now let’s try to estimate the benefit of deducting mortgage interest. On a $575,000 loan, the amortization schedule says that $34,308 of interest will be paid during the first year (it will be less each subsequent year). Everyone already gets the standard deduction of $5,350, leaving us with a net benefit of $28,958. With marginal tax rates of 28% federal and 9.3% for California, that is a savings of $10,801/year ($900/mo). Adding that back into the net pay, that leaves us with 67% of net take-home pay going towards housing costs alone. Still pretty tight, but I suppose a person could still manage if they were very careful. As the wise folks say, just because a bank lets you borrow something, doesn’t mean you necessarily should…
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Our banks pre-aproval was about 2/3 of our take home. We couldn’t believe someone would try to live off of that. We quickly found a range of houses that was 1/4 our take home in monthly payments and have been living comfortably for the last year in our new home.
I went the pre-approval route and got my home when someone else had already offered more. I wasn’t interested in playing games when I heard a friend of the seller was interested in buying, so I needed to make my first offer my best offer. So I intentionally low-balled, but my superior financing was accepted even though I offered lower than I had originally figured I would just because I was a little irritated in the situation.
Also, I had checked rates and went with a mortgage banker instead of a broker. I’m not sure if that helped my position, but it seemed to be the general position that I was viewed as having fewer challenges since I was pre-approved and the people I was working with for that were actually the ones providing the funds. I couldn’t tell from the blog if you’ve talked to any mortgage bankers, or just brokers, but it’s an interesting area to look at, I think.
Pretty tight until Murphy moves into the spare room. Then financial ruin is around the corner.
I’m in the process of getting pre-approved. I got good faith estimates from 3 banks (2 national, 1 local) and 3 brokers. I ended up going with a broker because they they took the time to answer many questions for me, seemed to be more accessible, beat the banks’ best rates by 0.5% and had some of the lowest closing costs. One of the banks would never answer their phone. Another looked down their nose at me because I wanted to do 100% LTV (yes, I looked at 80/20 also) and the other’s rate was not attractive. Nine times out of ten I can get my broker on the phone immediately. He is very responsive to email and is walking this newb through the whole process. To be fair, the other two brokers were not that great. One made many errors that I had to correct in his GFEs, the other took a week to get me one. But if a broker provides great service and easily beats the banks rates and closing costs, why not use one? Of course, YMMV.
Of course, as a married couple, your std deduction is over $10k, which reduces the deductable interest benefit to ~$733/mo in this example.
Either way, it is about $2000 left over per month to pay for everything else in your life assuming some tax benefit. You could live on that as a married couple with no kids, but you would be paycheck-to-paycheck, and any sudden expense might put your house in jeopardy. It is hard to believe that banks would lend money in such situations and not charge a higher interest rate to compensate for the risk of default. Also, wouldn’t a $575k mortgage be “jumbo” and get a higher rate than 6%?
I found out the hard way that pre approval / pre qual or even a loan committment letter means nothing. They all contain so much fine print you really cannot be sure that your mortgage is approved until the underwriting process is approved and your loan docs are generated. ETRADE issued all the approvals including a loan committment letter and then pulled the loan the day before closing because the investor/owner occ ratio was too high.
Fortunately Countrywide was able to turn around a new mortgage within 24hrs and I still closed on time.
In the hot real estate days the underwriters were so busy that they normally didn’t get to looking properly at your loan until 2-3 days before closing. I suspect it is different now.
My 2 cents of advice is to set the financing contingency date as close as possible if not the same as the closing date. This way you are protected.
A 6% mortgage interest rate? Is that reasonable?
Your loan is a jumbo loan with 0% down. The interest on that should be quite high. You are either getting 2 loans ( a 1st at 80% and a 2nd at 20%) or you are buying PMI.
The 1st loan for 80% could be 6% if it is a jumbo 5/1 ARM (average rate at bankrate.com), but the second 20% will probably be at like 8% or so…
For a fixed interest loan, the interest rate would be even higher (starting at like 6.5%)..
Anyone that listens to a mortgage broker or realtor on what they should borrow is setting them self up for trouble. These people are no different than a car salesman, just without the slicked back hair and overpowering cologne.
When I bought my last house I was moving into a more expensive area. I knew what I was going to make and I knew what my budget would look like. I knew what I could afford. I told the broker and the agent how much I wanted to borrow and how much house I could afford. They would’ve been more than happy to sell me something 50% higher than what I bought.
I was stunned too when I started searching for preapproval numbers last year. I qualified for more than double the mortgage I felt comfortable taking on!
Now I work as a private banker–where my primary job is to lend money for things like homes, boats, cars, businesses, etc. I will tell you that at our bank it is a policy violation if the borrower’s DTI is over 40%–but we can still do the loan if we really want to in that case. AND we calculate DTI based solely on debt payments–not taxes or insurance payments.
Of course, this is in the private banking division, where presumably clients have high incomes and assets–the actual mortgage division is more conservative I think.
Not all brokers are like that, but many maybe most are. In any case, with big decisions in life like buying a home you need to do your own homework. Understand your budget and what you can afford. Understand the home buying process and how mortgages work, the different types and use the calculators at sites like dinkytown to run some scenarios. Make sure you understand what your property taxes and insurance will be. If you live in a high property tax state like Texas, it can seriously impact your total monthly payment. And shop around not only for the house, but for the mortgage. If you go to a broker and tell them exactly what you want because you know what you can afford, then they won’t be able to sell you a bad financial instrument on a house you can’t afford.
I like this simple affordable home calculator: http://cgi.money.cnn.com/tools/houseafford/houseafford.html
We bought a 1,500 ft house (not big, not small since US average today is somewhere around 2,200 ft) last year. The monthly payment (mortgage+insurance+tax) is now just 15% of our (wife and I) income today. It’s good to live below our mean. We’re able to continue to maximize our 401k+roth and travel a lot since the house expense is virtually nothing.
By the way, nobody lives in the same home for 10+ years. So, get a standard 3bd-2bth house/condo, which has enough rooms even with kids.
Are you sure this is even the right climate to consider buying a house? I was going to take the plunge months ago until I saw how bad the market was. Now I’ve decided to continue renting for the next 2 years. I really don’t see the housing market rebounding for another 3-4 years. Housing cycles tend to last a long time.
I’ve kept my “house purchase money” in stock investments and they done tremendously well. Putting the money in a house at this point in time might not be the best idea. But I guess if you see it as a priamry residence and not an investment that might be a different story.
-Raymond
Jonathan, I was a little confused by the following:
>>
Example: 28%/36%). The bottom (lower) number was the max ratio allowed for [housing] divided by [gross income]. The top (higher) number was the max ratio for [housing + other debt] divided by [gross income]. You had to be below both ratios to qualify for the loan. But I was told that if you have no other debt, that we can bump right up to the top value.
Jonathan, I was a little confused by the following:
>>
Example: 28%/36%). The bottom (lower) number was the max ratio allowed for [housing] divided by [gross income]. The top (higher) number was the max ratio for [housing + other debt] divided by [gross income]. You had to be below both ratios to qualify for the loan. But I was told that if you have no other debt, that we can bump right up to the top value.
(Sorry – original message got cut off) The top number here is lower, not higher. If you have no other debt, which number do you use? 28% or 36%?
@MBB,
Even if one were to take your estimate of 3 – 4 years (which I probably wouldn’t argue with) why would you want to buy during a rebound anyway? If its low now, buy low!
however, if you have a 100,000 income and a non working spouse, the tax benefit is a lot lower! you may get a tax benefit of around 10k only with both spouses working and with a 100k joint income.
I agree with Ken, buying a home is a big decision, so you really need to do your homework, in the end you make the decision, not someone else. If you understand what your getting yourself into, a payment increase or a huge propety tax bill shouldn’t be a shock.
I bought my place 2 months ago, while a lot of people telling to hold off. You do what you feel is right and you stick with it. You always hear prices falling but it’s always in areas where job market is weak and plenty of land to build. I live in the bay area and I can name you plenty of places where prices are still strong.
A 5.75X multiplier is absolutely insane! It wasn’t that long ago that the multiplier was a mere 2.5X. Similarly a DTI > 40% is just asking for trouble.
New math at work I guess. It’s no surprise we’ve got people over-extended with housing costs if lenders are really allowing 40%+ DTI and a 5.75X salary multiplier. Add to that the extra cost when buying the bigger house — heat/AC, water for the bigger lawn, and all those lights. My *winter* electric bill nearly doubled when I moved into my new home a few years ago — all due to lights (like, umm, why are there 3 100 watt bulbs in the laundry room, master closet). Replacing everything possible with CFs brought the bills back into the sane range.
If I plug in the #s from the new math relative to my salary prior to semi-retirement, I get a number for a house that is mind boggling, even for the over-priced, supersized, SLC housing market. I can’t imagine purchasing that much house or the required payments.
FWIW, I won’t even accept renters into my properties with those kind of debt/income ratios. It’s simply too risky for everyone involved. If they’re even approaching 40% DTI (where rent is treated like one would a mortgage payment), then it’s a major red flag. It’s probably no surprise that after renting from me, my tenants are well prepared for ownership 🙂 My last move-outs (5yr tenants) split up, moved to different parts of the country and each purchased a home.
Jeff
Evan, well I think it probably involves some timing, but I’m predicting at least 3-4 years before we see a positive bounce. Based on that, one would try buying in 2 years.
Why have your money not go anywhere for 2 years? I think waiting is a better idea.
-R
I am buying a house in the next 6 months. I wouldn’t wait for the rebound and I do agree with Evan. I say buy now when there is confusion, uncertainty and panic among sellers and buyers. What I mean is go and low-ball. Recently several people I know where able to get amazing deals right here in the bay area, one of the most expensive real estate markets in the world. See the difference is when you try to make a deal now, chances are you’re the only buyer in line. (for most areas in the country, not all). Therefore you can work with the numbers, the seller are thinking they better take it since there is uncertainty about the future of the market. If you wait until the actual rebound to happen, then guess what. Everyone and their moms are thinking the same thing. Sellers know the market has bottomed out so they are not willing to work with you on numbers, buyers know its the time to buy so they are actually going to buy and all of a sudden you’re not the only buyer on the block. I would say buy within the next 6 months for most markets. I’m buying a house and some investment property in the Houston area and you bet I’m going to lowball like crazy and chances are I’ll put some deals in contract.
With regards to pre-qual letters from brokers, they mean nothing. I’m a licensed CA agent and when I used to work with residential property I would call my friend (long time mortgage broker) and tell him, hey send me a prequal letter for so and so. 10 minutes later its in the fax. Savvy listing agents and sellers know those mean nothing. A pre-approval is when its actually through the bank and they have verified that you can get the loan you are applying for.
@MBB,
Have to keep in mind,
a) You know its depressed now, jump on it, before the Fed drops rates and housing picks up again (one in the hand, two in the bush mentality)
b) your home is NOT your investment, but rather a questionable savings vehicle
3) You have a nagging wife/fiance that wants a house
#3 is HUGE
@MBB
It also depends on the market in question. I’m about to buy a house in market that had houses appreciate in value last year by about 10% and it was featured in several articles as one of the most undervalued markets in the country.
Now people from California are buying up houses in this town to try to get back some of their losses back home.
Thanks guys. 😉
Yes, the actual take-home % might be somewhere between 67 and 78% depending on all the variables, I just made some general assumptions and ran with them. But whatever it is, it’s a lot! 🙂
err…..when the market is down….its time to buy!!!!!!!!!!
I went through this a couple years ago as a *seller*. At that time there was already a problem with pre-approved buyers who had basically called mortgage broker or bank and had ten minute conversation to get their pre-approval. My RE agent wouldn’t have anything to do with people making an offer unless they went through a full pre-qualification and she could verify they were approved for $X loan with $Y dollars down payment to match their offer. She ran her own RE brokerage with a dozen agents and was saying there was a 30 to 40% failure rates on pre-approved offers.
Paul
OK, I got a feeling that you just want to proof how loose the loan/mortgage brokers are on their landing standards and that’s the root cause of our current landing crisis. Point well taken, but you have to realize that the mortgage brokers are sales people, they want to hook you up and make you their client. The initial sales pitch is always rosier than the actual final loan process. Any sales should attract your business by giving you an impression that you are in the market and you can afford whatever you wish for. That has nothing to do with exactly how much you can afford or the bank is willing to let you borrow.
Based on the comments here it looks like we’re still pretty high up on the decline side of the Real Estate cycle curve Jonathan presented on 8//11/07 and 1/4/07.: https://www.mymoneyblog.com/archives/2007/08/housing-bubble-talk-the-real-estate-cycle-is-moving-along-nicely.html
I saw a graph earlier today that showed the volume of resets expected for the Sub-prime loans and the Option ARMs (which, until now i thought were included as Sub-prime loans). While the volume of Sub-prime resets is expected to peak late in 2008, the volume of Option Arm resets isn’t expected to peak until 2011. This makes sense considering all of the Option ARMs that were sold in 2005 and 2006. So, while Subprime is the word of the moment, pretty soon Option ARM will have it’s shot at being to blame for the country’s economic mess. I wouldn’t expect house prices to rise or stay put knowing the Option ARM mess that’s still to come.
Happy House Hunting!
I’m surprised that you are using a DTI of 50%, the lenders I’ve talked to won’t lend above 40% DTI and that was before the sub-prime meltdown. They typically want the DTI below 35%.
The DTI has extra components too, if you have school loans, HOA dues, credit card payments (0% BTs) all of those usually get factored in…
For 100% LTV 6 percent is a very low rate – you’d have to have a second at a higher rate or PMI.
In summary the numbers you are using do not seem realistic. Lower your DTI to 40% and assume an 80% loan at the good rate and a 20% loan at a higher rate and you’ll be closer to what banks will actually lend you…
I know this isn’t the point of this post, but in your example, wouldn’t that hypothetical person be itemizing state taxes anyway, therefore the all the interest deduction would be on top of that?
It is totally insane to buy a house in the bubble zone (CA, NV, AZ, FL, and pockets elsewhere) for the next 2 years. Next year is going to be the rollercoaster ride–this year is just the “losing your stomach feeling” at the top of the first hill.
The key predictor of home prices is the ratio of foreclosures to sales. There’s some excellent info and charts at piggington dot com, as it applies to San Diego. To make a long story short, the foreclosure rate is off the charts and climbing vertically. Until the number of foreclosures GO DOWN for a few years house prices will keep falling.
everyone that says oh im not buying because real estate prices are down/inventory is high ARE NUTS. youre basically saying that you are going to wait until everyone else starts buying again, which drives the prices higher and then you will buy… everything is cyclical. within the next 2 years, if you are going to buy a house, you should do it. you will likely be able to get quite a bargain, interest rates should still be relatively low, and IMO you should buy your primary residence for personal reasons and not as an investment. spend what you are comfortable with and buy a home that you will keep for many years to come. improve your quality of life. buy buy buy. fyi rents will be steadily increasing over the next few years…
Wow! It’s amazing how many people actually believe they can afford payments that high just because they were approved for thst much of a loan. I have seen several people go through situations like that. It’s ugly. 🙁
Having 67% of net take-home pay going towards housing costs is a recipe for disaster. Also, how come they calculate your maximum mortgage on your gross income, when it is your net income that will actually be paying the bill?
I’m not sure about 50/50 DTI you used in the first calculation. Most A paper lenders/banks guidelines require DTI not to exceed 42%. As for 100% LTV (loan to value) for the theoretical mortgage, you need to consider couple of other things.
1 It’s very unlikely that you would be able to obtain a rate of 6% for a mortgage with 100% LTV, since there are hits to the rate for anything over 80%LTV. The closer approximation would have been something around 6.750-7.000%
2 With anything over 80%LTV you would need to pay PMI (insurance on the mortgage), which assuming a credit score of over 720, ability to go full doc (support income with documentation), and loan coverage of 35% (as required by bank) would add another $460.16 a month.
So in reality you would have about 5% of income left over for all other necessities
My wife and I bought a house in July. When getting pre-qualified, we assumed a 5% down payment, and our annual gross was about $130,000. Our broker ran the numbers through his engine and came out with $825,000. “It really loved your credit scores,” he said.
The place we bought didn’t cost that much, of course.
FYI, just a reminder for primarily condos or townhouses that have HOA or condo fees… from experience, some lenders consider this in determining the PITI for a specific property, others do not consider it. And, i’m sure you may have seen some condos with condo fees from just $125 all the way to $400 a month! (not including your PITI).
So most if you are saying that you agree the market is down and we should consider buying. ( buying low i.e.). But is the market down now and continue to get lower or is it on the rebound?
Given housing prices are stiky downwards, it might take atleast a good two to three before we even reach the lowest point.
People who are buying to get the good deal because of the”frenzy” is what keeping the markets still alive. When they wore off, and believe me they are the last ones to get out, you’ll for sure see the prices tank more.
while i’m not even really considering a home purchase at this point in time, i would like to learn more about it for planning purposes/etc (could potentially put 20% down on a relatively inexpensive smallish house (100-150k?) in the southeast in the next couple of years….. and maybe put a roomate’s rent toward the mortgage).
Anyone have a good site or two that you think is helpful for this topic? (other than this blog :P)
(yes, i can use google. if you have an actual site that you liked or thought was helpful, please share 🙂 )
In today’s market, is it still possible to get a 0% down deal? I thought that in light of the recent housing crises, that this was impossible?
And if you do have ANY kind of deposit, I still believe that the best time to buy is NOW !!
(Sell when everyone is buying, and buy when everyone is selling 🙂 )
1. Don’t buy yet. Approximately 2 Million homes have ARM resets between now and next August. This means foreclosures will be skyrocketing through 2008. Eventually, home sellers will realize prices must drop. When you have too much product on the shelf, the store drops the price. Homes are no different. It just takes homeowners longer to understand this and adjust prices.
2. Keep your multiplier to 4X your salary and debt to income to 36% or less. Anything beyond that and you are asking for trouble. If you want a bigger home than you can afford, then save more or earn more money.
3. Always base the amount of home you can afford on your budget, not realtors or mortgage lenders. There are very good realtors and brokers out there, but you must realize they have an incentive to get you to do the deal in as big of a house as possible. There is an enormous conflict of interest.
I’m not sure I see why people think this is so crazy as an *upper limit*.
Take my example: a number of years back, as a graduate student, I purchased a 2 bed 2 bath condo for approx 150k. At the time, I received a stipend of 25k gross income. With the good interest rates of the time, this meant I was paying about $600 a month in mortgage, $150 a month in condo fees, and lets say $100 a month in utilities and insurance. I also took in a roommate to share the place with, who paid me $450 a month. Sure, housing remained a large part of my budget – but, with no debt and no kids and liking to cook, that was fine with me. Since then, the place has appreciated, my income’s gone up, I’ve gotten married and my husband has moved in… it’s been a fantastic arrangement!
But, notice that this loan was SIX TIMES my income. That’s a lot! Yet, it was a smart decision for me. Just taking the number given as an upper bound and saying “wow, that would be ridiculous for me!” isn’t necessarily a fair way to judge it as an option for others….
k –
Although your example worked for you, “a number of years back”, your point is not relevant in today’s terms. First of all, good luck finding that 2b, 2ba condo for $150,000.
looking for advice:
I am about 5+ years away from my down-payment savings goal to get the home I want. Should I buy something earlier (within a year) that is nice, but not my dream home, and less expensive with the hopes that the value will grow over the next five years and then I can I buy my dream home?
I agree with posters above who said that prices are likely to come down more. Just an opinion, but I think that real estate situation doesn’t change overnight. When there is a turn-around and the prices start going up there’ll be plenty of time to react, IMHO.
A few years ago my friend was buying a house, and I was surprised that she could get a mortgage for over 3 times her gross. She said – oh, they don’t care right now, you could get 4 or 5 times gross too. I thought to myself – this cannot last, we are bound to see foreclosures. I didn’t even know about all these crazy mortgages; ok I maybe heard about it because a collegue at work got an ARM. but while I thought he was crazy I didn’t put two and two together and didn’t think of how it’ll affect the whole market. With I had reacted in some way, maybe shorted some mortgage stocks, but I am a chicken.
Michelle, if you live in an area where prices are predicted to fall significantly (google for “fiserv house forecast 2008”, for example), then wait until things look better. It costs about 8% of your existing home’s value, and a lot of effort, to switch houses. So to make the strategy of buying a temporary house pay off, the house would have to appreciate by over 8%. You can make 4% after taxes on a CD (certificate of deposit) with less risk. And if house prices fall, you’ll be able to buy your dream home sooner anyway.
I agree with kitty that “When there is a turn-around and the prices start going up there?ll be plenty of time to react”.
@Phoenix
I think it’s an issue of where in the country you life. Where I live, that would still be easy – there’s one for sale for that down the street from me that’s not even moving. And this is a nice, safe neighborhood with close access to amenities and public transit.
The thing that’s less relevant right now is the interest rate that I got. But, I still think that even without a ridiculously good interest rate, what I did would have made sense, and claims that “it’s just flat out crazy that a bank would ever approve a mortgage for 5x someone’s income” are in part resting on a somewhat narrow view of what kinds of situations people might be in when purchasing a home.
Thanks for the opinions. I live in southern NH which is a fast growing area as Greater Boston keeps moving north. The home I want is a converted mill foreman’s home. It is a small condo association in downtown with it’s own greenspace. Georgeous and historic! I have been watching the prices of these for 2 years and they aren’t moving down at all. The trend in my area seems that homes are on the market longer and new construction is even offering free upgrades and even cars, but no one is lowering their price much. I guess I just need to be patient. I have my home savings in a money market and periodically a CD.
I’m getting different numbers with different calculators. I’ve tried http://www.mortgagesum.com and http://www.bankrate.com. Credit requirements are a lot tighter these days so I’m plugging in 20% downpayment.