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.

Tips and Tricks: You may be able to increase your purchasing power by:

1. 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.

2. 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.

3. 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.

4. 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.