When you decide to buy a home in Washington State, pre-arranging your financing is the logical starting point. Sellers need to be reassured that you’ll be able to get a loan and complete the transaction, but you also need to know the particulars of the loan you will probably have for a number of years. The lender will look very carefully at certain numbers as well, when they review your file and approve your loan
The numbers and terminology may be unfamiliar, since you will only go through the process a few times in your life but knowing the mechanics of your loan approval will make the process much less stressful. Here are some of the numbers you need to know about.
Your Credit Score
Most consumers have three FICO scores—one from each of the three major credit bureaus (Experian, Equifax and TransUnion). The scores are typically different for each of the bureaus, partly because they often compile different credit data, and partly because they use a slightly different formula of the FICO scoring system.
The lender will discard the high and low scores. The remaining number is called, predictably, the “middle score.” This is the one lenders use when they review your loan. When there are two or more borrowers applying for the loan, the lender will use the lowest middle score.
The minimum permissible score for a conventional loan is 620. Government-insured FHA loans are a bit more forgiving. They’ll allow a score as low as 580 with a minimum down payment of 3.5%.
Your middle score will determine the interest rate you get. A borrower with a score of 620 will get a rate about .625% higher than a borrower with a 740 score, everything else being the same. For a $450,000 loan, the difference in rate between the highest and lowest means a $170 difference in the monthly payment.
There is a common narrative still making the rounds, that lenders require near-perfect credit to approve a mortgage application. This is completely false. While having a lower credit score increases the cost of a loan (especially when mortgage insurance is involved), a lower score is not the deal-killer many people think it is.
The rate you can get will determine the size of the loan you can qualify for. This is because of another important number.
The Debt to Income Ratio
The lender wants to know you have enough income to make your house payment and cover other expenses, such as car loans and credit card payments. To make this decision, they calculate the debt to income ratio, or DTI. They do this by adding up the total house payment including taxes, insurance and mortgage insurance, if any. If you are buying a condominium or townhome, you’ll pay dues to the homeowner’s association each month. All these items added together make up the housing expense. Because your credit score determines the interest rate you get, the higher rate one would get from a lower credit score would increase the monthly payment and the housing expense.
The lender adds any debt payments you have to your housing expense. They’ll include any accounts appearing on your credit report: car loans, student loans and credit card minimums. Any required payments for alimony or child support will also appear in the total. Other obligations such as current rent, utilities, cable TV and cell phone bills are not counted.
The total of your proposed housing expense and other debt payments divided by your gross monthly income (before taxes) results in the DTI. If you earn $8,000 per month before taxes, are planning on a total house payment of $2,400 and have $800 in other monthly debt service, your DTI will be 40% because the total of your house payment and other debt service is $3,200. A lender can approve a conventional loan with a DTI as high as 50%.
Loan to Value Ratio
This number, which is referred to as “LTV,” is the loan amount divided by the property’s value. A home worth $600,000 with a $480,000 loan has an 80% LTV.
There are loan programs that allow LTVs as high as 97%—a 3% down payment. It is important to be aware that a loan for more than 80% of the home’s value will carry some form of mortgage insurance. Most people today have seen the term, “PMI.” This stands for Private Mortgage Insurance. Because the smaller down payment carries more risk, lenders require a way to limit their risk. That is where PMI comes in. It enables the lender to lend you money when your down payment is less than 20%. Since the down payment for the majority of buyers today is less than 20%, PMI is common, and important to be aware of.
Just as your credit score determines the rate you can get, it will also determine the cost of monthly mortgage insurance. For a 90% loan (10% down, the monthly cost can range between .30% for someone with a 760 score to as high as 1.10% for a borrower with a 620 score.
Now that you are aware of the most important numbers in your loan application, you have taken a big step toward lowering your stress as you go through the process.