Qualification
Take advantage of our Qualification Calculator to begin the
process of determining the home value for which you qualify.
You'll also need to discuss your particular financial details with
a mortgage company. Like most industries, the mortgage industry
uses its own jargon. Understanding the terminology of the industry
will serve you well in understanding the process of buying and
financing your home. Here is some terminology you will need to
understand:
- Application: The loan application is a comprehensive
document representing the borrowers income, expenses, assets,
liabilities and net worth. It can be considered both an Income
Statement and Balance Sheet of the borrower. The application
helps the lender determine the borrower's credit-worthiness.
- PITI: An acronym for Principal,
Interest, Taxes and Insurance.
Principal and interest refer to your monthly mortgage payment.
Taxes and insurance refer to 1/12 of the annual property taxes
and insurance premium. PITI is designed to represent the monthly
cost of home ownership (total housing expense )
for qualification purposes. (Total housing expense can
include PMI and association dues if applicable.)
- Gross Monthly Income: Gross monthly income is your
monthly income before income taxes. You are usually given full
credit for your base salary. Overtime, commissions and bonuses
are usually averaged over the previous 24 months. If you are
self-employed, the income reported on your tax return
will usually be averaged over the previous 2 years.
- Front-Debt Ratio (top ratio): Your front debt ratio
is your PITI divided by your Gross
Monthly Income. This qualifying ratio
is used by the lender in making a decision to grant or deny your
loan request.
- Back-Debt Ratio (back-end, bottom, total expense, total
debt ratio): Your back-debt ratio is PITI + Other
Monthly Debt Expenses divided by your Gross
Monthly Income. Other monthly debts include auto loans,
credit cards, person loans, student loans, etc. Your phone and
electric bills are NOT considered part of your debt expenses.
This qualifying ratio is used by the lender in
making a decision to grant or deny your loan request.
- Loan to Value (LTV): LTV = loan amount divided by the
property value.
Here is an example of how the above information is used:
- Monthly base income: $5,000
- PITI: $1,000
- Other monthly debt (credit cards and student loans): $600
- Home purchase price: $100,000
- Down payment: $20,000
With this information, qualifying ratios and the LTV can be
calculated:
- Front-debt ratio: $1,000 / $5,000 = .20 or 20%
- Back-debt ratio: $1,600 / $5,000 = .32 or 32%
- LTV: $80,000 / $100,000 = .80 or 80%.
Mortgage companies and lenders like to see qualifying ratios at or
below acceptable levels set by the industry. Acceptable qualifying
ratios denote a borrower's ability to repay the debt. A low LTV is
also desirable. The lower the LTV, the greater the equity the
borrower has in the home, and the more secure the lender's
investment. As the LTV increases, acceptable qualifying ratios
decrease.
Here is a table of LTV and maximum qualifying ratios used in the
industry. These ratios are general guidelines only. In
practice, lenders make their own decisions based on a number of
additional factors such as your credit history, length of
employment, etc. Please check with your mortgage company regarding
your particular situation.
| LTV |
Front-Debt Ratio |
Back-Debt Ratio |
| 90.1%+ |
28% |
36% |
| At or Below 90% |
33% |
38% |
Tips and Tricks: You may be able to increase your
purchasing power by:
- Paying off debt:This would reduce your back-debt
ratio. Many lenders do not count the monthly payment on your
installment loans if you have fewer than 10 payments left. If
you have a car payment with 12 payments left, you may want to
consider making additional payments to reduce your total
payments left to under 10.
- Making a larger down payment: This reduces your LTV,
total housing expense and provides for higher qualifying
ratios. If you make a down payment of 20% or more, you
won't have to pay PMI.
- Borrowing against your 401(k): You can sometimes
increase your purchasing power by using the proceeds of your
401(k) loan to pay down your other debt, or to use it towards
the down payment. This can be a little tricky, so please consult
with a mortgage professional.
- Obtaining a margin loan: If you own stocks and do not
want to sell them, your stockbroker may be able to arrange a
margin loan, using your stock as collateral. Since a margin loan
has no monthly payments, this generally does not affect your
debt ratios. You may use the proceeds towards the down payment
or to pay off debt.
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