Across the country housing prices are making new highs on what seems like a daily basis. It doesn’t seem to matter where you look-multiple bidders on homes and bids over asking price have become the norm, and buyers feel stretched beyond their financial comfort zones and their budgets.
I reached out to one of our trusted resources recently, mortgage broker Travis Gillespie, for his take on the market and to get a good understanding of what buyers should know when it comes to qualifying for a mortgage. We share what we learned below.
Started Looking for a House? Ask Yourself Two Questions
- What are you paying for rent or mortgage now? Will buying a more expensive home change your monthly costs significantly?
- Where is your financial comfort level? Can your budget handle a significant increase to your monthly housing costs? Remember, too, to add in higher property tax and insurance costs.
Interestingly, Travis shared that most people qualify for less than their “comfort level.” Which leads us to believe that people would stretch themselves further than they should go if they qualified for the loans.
Found the House of Your Dreams?
If you plan to finance with a mortgage here’s what you need to know to qualify for a loan.
There are two major types of loans: conforming and jumbo, and there are four numbers you’ll want to remember here-43 and 45, 740 and 760, and they depend on the type of loan you are applying for.
Conforming loans are loans that fall under a maximum loan amount. This is determined by the government and based on the affordability of where you live. It’s also based on the county in your state.
The highest conforming loan in the US is currently $822,375 and this is only in the most expensive locations in the country. In San Diego, for example, the highest loan limit in the county is $753,000. Across the US in less expensive locations the conforming loan limit is $548,250.
When qualifying for a conforming loan lenders use what is called a Back End Ratio to determine the maximum monthly payment you could qualify for. This ratio is 45% of monthly gross income.
For example, if 45% of your monthly gross income is $6,000 and you have monthly debt payments of $1,000, that would leave $5,000 as your maximum monthly mortgage payment, including principal, interest, tax, and insurance.
Understand the Debt You are Taking On
Let’s talk about the debt piece. A lender will pull your credit report to determine your monthly debt. Only those bills that show up on a credit report are taken into account. Other payments like child support, alimony, tax liens, will all be included in that monthly debt number. Expenses like groceries, gas, internet, anything not on your credit report will not be considered in the debt number.
If you want a loan larger than a conforming loan, that would be a Jumbo loan. Lenders use a different ratio for qualifying for Jumbo loans and that is 43% of gross monthly income. Unlike conforming loans, Jumbo loans are offered by private institutions. When it comes to qualifying, the institutions set their own rules. One common requirement is that reserves are needed in addition to satisfying the 43%.
How Does Your Down Payment Affect Your Options?
The type of loan you get – conforming or jumbo – will have different down payment requirements. The minimum down payment for a conforming loan is 3%. This means you can buy a house with a conforming loan with only 3% of the purchase price as down payment, but any down payment less than 20% will mean you pay something called PMI which is added to your monthly mortgage bill. PMI stands for Private Mortgage Insurance and it is a banks way of insuring against potential default.
How much is PMI? This will depend on your credit score, and on how much of a down payment you are making. A FICO score of less than 760 will mean paying a higher PMI. PMI will decrease the greater your down payment.
Jumbo loans require a minimum of 10% down payment. In the case of Jumbos, PMI would be built into a loan in the form of a higher interest rate. So, while many lenders say Jumbo loans do not have PMI, the fact is that the interest rate you’d qualify for would be higher to accommodate that mortgage insurance.
Improve Your Credit Score Wherever Possible
Credit scores pay a big part in the interest rate you qualify for, and again, this depends on whether it is conforming or Jumbo loan.
For conforming loans 740 is an important number. Having a credit score above 740 will qualify you for the best interest rates. If your score falls between 640 and 740 the rate you qualify for will depend on where you fall in this spectrum.
Expect about a 1/2% increase in interest rate at the 640 level. That said, if you are able to put down a significant amount, say 40%, you can make up for the low credit score. You should still expect to pay more than if you have a 740, but not the full 1/2%.
For Jumbo loans 760 and higher is the credit score you should aim for. In the case of Jumbos the higher your credit score, the better the rate. This especially matters if you do not have a large down payment.
The numbers above will change for investment properties or second homes. Both of these will require reserves, which will be tiered and depend on the number of properties and mortgages you hold.
Interest rates for second homes are a little higher than those for primary residences and will require a minimum of 10% down payment. You can expect interest rates 1/2-3/4% higher for investment properties, and a 25% down payment.
Stay Calm in an Ever-Changing Property Market
A lack of inventory-50% of usual inventory-and low interest rates have caused the spike in housing prices. Now many houses are selling above appraisal value. This causes challenges for buyers who need to be prepared to make up a shortfall in appraisal if the house does not appraise for what they’ve offered to pay.
What will cause the market to slow down? Rising interest rates, more inventory, buyers choosing not to over pay for homes will all contribute to a slow down in the break neck speed of price increases we have been seeing.
Travis expects we’ll see higher rates towards the end of 2021. He also believes we’ll see more inventory as eviction moratoriums end, capital gains rates increase. He also believes the market will cool as interest rates rise and buyers sit out the market. For sure, the current prices of homes are unsustainable.
Build Your Team of Experts
If you work with us you know we are focused on expenses and your cost of living. So back to that initial question we asked-how will your monthly cash flow be impacted if you add a larger monthly payment for a more expensive home? How you answer this should give you an idea of whether it makes sense to jump into the hot water, or wait it out a bit.
If you would like some professional guidance as you set out on your home ownership journey, our WealthChoice team would love to hear from you. Get in touch and let’s help you feel at home with your home buying!
