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Purchasing a Home...Page 2
Jargon
You need to understand 3 terms to follow the rest of this:
- Loan-to-value (or LTV). This is the loan amount as a percentage of the
purchase price or appraised value (whichever is less). If you are buying a $150,000 home
with $15,000 down payment you have a 90% LTV. Loans over 80% LTV require either PMI
(Private Mortgage Insurance) or a combination of a 1st and 2nd mortgage which avoids the
PMI. For "expensive" homes two other rules apply. PMI stops (in general) at
$400,000 loan amount and as loan amounts get progressively larger either a lower LTV is
necessary or you are going to get restricted to certain loan programs. These are usually
going to be adjustable rate loans or fixed rate loans at a "Premium".
- Housing ratio. This is your total monthly housing expense (principle,
interest, tax, insurance, and PMI and homeowners dues, if applicable) divided by your
gross monthly income. Note "gross" not net. If you have a "W2" job
your income is easy. If you are self employed please note you gross income is what you
bring from your Schedule C onto line 12 of your 1040. Also, a 2 year history of consistent
self- employment income is necessary
- Debt ratio. This is your total monthly obligations (PITI above) plus
your monthly payments of your installment and revolving debt. Some details here: this
would include child support, alimony or separate maintenance. Any debt with fewer that 10
months to go does not count. A debt such as a "buy furniture now make no payments
until more than a year from now" does not count as long as there are 12 months to go
without payments. The same goes for student loans.
We often see young couples "blow it" by buying a couple of nice cars. If you
are spending 15% of your gross income on your auto loans you are going to have difficulty
buying a house.
OK, Now What?
If you have excellent credit you can buy a home with 5% down and with housing and debt
ratios as high an 38% for housing ratio and 44% for debt ratio. As your credit score
declines your maximum LTV will decline and your ratios will have to be lower. If your
credit is really lousy you should plan on having to put 20% down. If your credit is
terrible you should wait several years until you can fix it before you purchase.
If you have good credit you may need a 10% down payment and ratios more like 35% housing
and 40% debt ratio. Please understand that none of this is etched in stone. Compensating
factors, such as a long time on the job or significant other liquid assets will enable
higher ratios at a given LTV. You really need to talk with a mortgage broker to sort this
out.
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