You want to be comfortable with the monthly payment of a loan. If your income cannot support a loan or if you do not feel comfortable with the monthly payment of a loan- with taxes and insurance- then you are borrowing too much money for your budget. The underwriting guidelines are that a bank feels comfortable with 33% of your income going to your home. There are programs that allow for 50% payment toward your home versus income, but the rates reflect this increased burden.
The question of how long should you have for the ‘fixed portion’ of a loan should be determined by the time horizon that you will need the loan, or stay in that house. Why have a 30-year mortgage if you know that you will leave the house in 5 years.
The 4 basic Components of a mortgage Loan.
The mortgage industry is a risk-based industry. The risk for a bank to loan money on an asset is offset by two things: the higher the interest rate and/or the more difficult to be approved for the loan.
Every loan can be viewed as a ‘four-legged’ chair. The analogy is based on the ability to obtain a mortgage or equity line on a property. There may be flaws in one or more of these four ‘legs’ or facets of the loan. The more solid ‘legs’, the less risk exists for a Lender and, thereby the better the rate.
The ‘four legs’ are as follows:
1) Credit. Everyone is given a credit score based on their past ability to pay bills and utilize credit.
2) Reserves. How much money do you have in Reserves? These monies can be in any form- Checking, Savings, 401K, Retirement Accounts, Stocks, Bonds, etc.
3) Income. This is the Bottom-Line Income provided on a W-2 or on a Tax Return. The most recent Payment stubs are usually required to ensure current employment and income levels. Stated Income Loans are an option for customers who: are self-employed, derive income from rental properties, etc.
4) The actual Deal or Loan-to-Value (LTV). The less debt as a percentage, the less risk a Lender assumes and, therefore the better the loan rates.
The ability to obtain a loan is based on these 4 components. If there are any weak ‘legs’ on the chair, then the borrower will not use a Full-Documentation loan, but rather must compensate by using Stated or No Documentation Programs. Consequently, the interest rates are higher and therefore, the monthly payments will be higher.
The best-case scenario is to have all four of these requirements in good standing. However, it is more likely that one of these criteria has shortcomings. There are many lenders who will not focus on a single problem area.
If two of these criteria are deficient, then it is more difficult to get a loan at a standard rate, however there are certain boutique lenders who will specialize in combinations of: minimal down-payment/ stated income or stated assets/ stated income and it is possible to get good mortgage rates.
Lenders are hesitant to loan money to individuals who fall short on three of these requirements, however if the borrower is willing to allow terms to be dictated by the lender (three year pre-payment penalties, 2/28 ARM products) then it is still possible to buy a property.
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