Understanding “Affordability” In the Home-Buying Process
Prior to Qualified Mortgage Rule (QM), also interpreted as “ability-to-repay,” lenders relied on credit, income and assets – the “CIAs” of homeownership. In our new regulated residential mortgage environment, we now rely on the “four Cs”: capacity, cash, credit and collateral. Although they appear to be the same factors, an in-depth evaluation on a borrower’s “ability-to-repay” now exists.
The in-depth analysis is known as a pre-approval and encompasses a detailed review of your finances. After this review, the lender will issue a specific amount of what they are willing to lend, helping you better understand what you can truly afford. In the past, a pre-qualification was acceptable, but it was only an estimate of what you could afford.
We had a lovely young couple purchasing their first home in the price range of $231,000 under FHA financing. It was a “to be built” property and they were pre-approved, prior to the start of construction. During the construction phase, the borrower was advised by the employer that there was a company-mandated initiative where sales income would be based on a reduced base salary, along with commissions. Fannie (Federal National Mortgage Association (FNMA) or Fannie Mae, and Freddie (Federal Home Loan Mortgage Corporation (FHLMC) or Freddie Mac required a two-year history of commission income, therefore, we couldn’t utilize commission income.
To further complicate the situation, the qualifying FICO score decreased from 640 to 546, which significantly influenced pricing, increasing total debt-to-income ratio above 43. We had no compensating factors since they were first time homebuyers. The loan no longer qualified under a Qualified Mortage (QM). We immediately submitted the loan for credit enhancement being able to obtain an improved score of 616, bettering the price and hence able to approve the loan under QM with total debt-to-income ratio below 43 percent.
The better you understand these “four Cs,” the more you will be prepared when it comes time to buy a new or existing home.
This is where the lender looks at your ability to pay back the loan. It is based on several factors, including (but not limited to):
- Debts – Housing and credit cards
- Employment history
- Other financial obligations – alimony, child support, etc.
The lender is really trying to determine if you can take on the mortgage comfortably. It is important to note that depending on the loan file, compensating factors could be taken into consideration. Those factors may include assets, job stability, housing stability, established savings pattern, or residual income. These could strengthen your loan file, making you a more attractive candidate for receiving the mortgage. It’s always best to meet with a mortgage professional to determine your entire situation instead of ruling out the possibility of obtaining home financing because you “think” you have too much debt or not enough savings.
Cash or Capital
This is your available money supply, plus any investments that you could liquidate and turn into cash quickly if there were an emergency. Acceptable sources of cash include: checking account(s), savings, CDs, IRA, 401(k), and gifts from family/relative(s). Having these types of savings or cash available show the lender that you know how to manage your finances and have the resources available to cover your down payment.
Confidence in a borrower’s ability to repay is also based on previous credit history. This report is pulled from one of three credit unions and you are given a FICO score. Your FICO tells a lender your creditworthiness, or likelihood you’ll pay your debts. The credit score scale is from 350 to 850. Most lenders grant mortgages to those in the 580 to 620 range.
The lender will also review the subject property as collateral. This type of appraisal cannot be determined ahead of time when getting a home loan in most cases. Appraised value is based on recent sales in the area, marketability, and property condition. This is an extremely important step in the process, as the lender will trust the licensed appraiser to give an accurate assessment to make sure the home is worth the price being offered.
The appraisal is a standardized estimate of the home’s value based on mechanical systems and structure. This should not be confused with a home inspection, which is highly encouraged in any home purchase.
If you believe you are ready to get started in the home buying process, contact a lender to get pre-approved. They will look at your “four Cs” and help you determine your home buying power before you get too far into the process – saving you time and frustration.
About the Author
Natasha Cartagena Spencer is the vice president and branch manager of Shelter Mortgage’s Florida Operations, which includes satellite operations in Texas, Alabama and South Carolina. She can be contacted at (407) 234-8504 or Natasha.Cartagena@sheltermortgage.com