When I wrote the first version of this article in 2000, I felt it necessary to emphasize to potential borrowers that they were not beggars who had to approach lenders hat in hand. There are multiple hundreds of lenders in this ong themselves for good loans, I told readers. That remains the case today, although the financial crisis has changed some of the rules.
An overview of what mortgage qualification means and its relationship to loan approval and affordability
A “good loan” is one to a borrower who has the ability to pay, the willingness to pay, and the capacity to make a down payment. Lenders base judgments of borrower ability to repay mainly on their income relative to their mortgage and other recurring obligations. They assess the willingness to repay mainly by the applicant’s credit history. They assess the capacity to make a down payment from the borrower’s current financial statements.
The term “qualification” is used in two ways. In a narrow sense, a qualified borrower is one with the ability to pay. Real estate agents qualify borrowers in this sense to make sure they will look at houses in the right price range. But qualification is also used in a broader sense to mean that the applicant meets all the requirements for approval. Approval requires that an applicant have the ability to pay, the willingness to pay, and an adequate down payment. Which meaning is intended is usually clear from the context.
On a purchase transaction, qualification is always relative to property value. A borrower who is well qualified to purchase a $200,000 house may not qualify to buy a $400,000 house.
The property value for which you can qualify depends on your own personal financial condition, and on the mortgage terms available in the market at the time you are shopping. To afford a $400,000 house, for example, you need about $55,600 in cash if you put 10% down. With a 4.25% 30-year mortgage, your monthly income should be at least $8178 and (if your income is $8178) your monthly payments on existing debt should not exceed $981. To develop the data tailored to your own situation, use calculator 5a, Housing Affordability Calculator .
Meeting Income/Expense Requirements
In general, lenders assess the adequacy of borrower income in terms of two ratios that have become standard in the trade. The first is the “housing expense ratio” (also known as the “front-end ratio”) and is payday loan in Havelock the sum of the monthly mortgage payment including mortgage insurance, property taxes, hazard insurance, and condo fees if applicable, divided by the borrower’s monthly income. The second is called the “total expense ratio” (also known as the “back-end ratio” or DTI) and it is the same except that the numerator includes the borrower’s existing debt service obligations, such as credit card or student loan payments. For each of their loan programs, lenders set maximums for these ratios, which the actual ratios must not exceed. Following the financial crisis, these ratios were increased, from with exceptions to with exceptions. Emphasis also shifted to placing greater weight on the more inclusive measure.
Lower Maximum Ratios on Riskier Transactions: Maximum expense ratios are not carved in stone. They are lower (more restrictive) for any of a long list of program “modifications” that are considered riskier. For example, the property is 2-4 family, co-op, condominium, second home, or manufactured, the transaction is for investment rather than owner occupancy, the borrower is self-employed, or the loan is a cash-out refinance.
* The borrower is a first-time home buyer who has been paying rent equal to 40% of income for 3 years and has an unblemished payment record.