Do You Have Too Much Debt?

Your Debt to Income Ratio is key to your loan approval. Here's how to beat the system.

Your personal Debt to Income Ratio (DTI) is an important factor all lenders use to determine your credit worthiness. This ratio is essentially what you earn against what you are paying out each month for scheduled debt. If you have a high debt ratio, then your monthly living expenses will usually start to suffer and most people will start missing payments or let their credit balances creep higher. This is murder to your credit rating as all your creditors will see this trend when they view your statistics. Once your balances rise, your credit score dives, and up go your interest rates! So it pays to understand how this works. Literally.

SAVE this Debt Evaluation Calculator link:
http://tinyurl.com/msn-debtcalculator

Essentially if you are over 30% of your availble credit balance and over 40% of your monthly income going out the door you are going to start seeing an impact on your score. Use this handy tool and check it often to keep yourself on track.

It is important to have control of your monthly debt payments against your monthly income. A high debt ratio might indicate that your monthly expenses are becoming unmanageable. A high DTI will discourage lenders from loaning you money.

Quick DTI Example for Monthly Gross Income of $4,000:
Mortgage including taxes and insurance (or rent): $1,000
Car payment: $300
Credit card minimum payments $200
Other unsecured debt: $100  (i.e, a computer or applicance account)
Total debt payments: $1,600 per month
= Total monthly debt ratio of  40%
This is considered acceptable and 'safe' range.

Let's add an item and see what happens
Medical debt or collection account: $400
Total debt payments: $2,000
= Total monthly debt ratio of 50%
This is becoming a bit high and you would be advised to lower it. 

Very few banks would let you borrow to a 50% debt ratio for a home mortgage or major purchase like a car loan.

Adding one more item to your home budget:
Student Loan Payment: $400
Total debt payments: $2,400
= Total monthly debt ratio of 60%
This is too high and and considered a risky debt level

Virtually all banks would deny your proposed $1,000 home mortgage payment with a debt ratio of 60%.

Why does DTI matter?
In the 60% DTI case above, you still have theoretically $1,600 income available for your use. This amount of  money is likely to be absorbed by taxes and other life expenses with no safety net in case something unexpected comes up. What happens if you have a major car repair or lose hours at work? A person with a 60% DTI is very unlikely to be saving or building up a retirement nest egg.

So unless you are a very careful investor who saves money and has few surprises in life, 60% DTI is considered very risky cost of living. If you happen to have several children and other responsibilities then even 40% could be a stretch for you personally.

How DTI Affects Your Mortgage-Ability:
With a 60% DTI, if you were applying for a mortgage you would expect to be turned down by every bank in town. As a mortgage planner, I would sit down with you and go over your credit report and help you identify what, if anything, can be resolved to assist you to qualify for a home mortgage.

DTI Strategy:
Let's say you wanted to buy a home within three months. If you have 6 months left on your car payment and it can be paid down to under 3 months - that really helps. (We can remove debts that are under 90 days to be paid off with good payment history).

In addition, if you paid off your credit cards and removed that $200 payment, you are again, improving your DTI. You might have a bonus coming at the end of the year that could be used for this purpose. If you can make a 3 month car payment (to bring your car loan under 90 days pay off) that would improve your ability to finance a home purchase today. Or we might decide to target your home purchase time frame within three months. Three months is a good time frame to be shopping for a home while you are improving your debt ratio, which by the way will also raise your FICO score.

At that point, if all other issues including your credit rating and history and income are acceptable, you would likely qualify for a $900 home mortgage payment for a total debt ratio of 45% or $1,800 per month expenses.

Note: Student Loans may be in 'deferred status' until you start working and once you are working and paying them -- usually at very low interest rates. If your student loans are in deferred status they may still be counted against your ratio - as you will be responsible for those payments eventually. Usually your student loan is not something we would target to pay off early, since credit cards and car payments generally have higher interest rates.

Why Does Your Bank Care about DTI?
Underwriters will ask many questions during a loan application if you are on the edge of your ability to make payments over the 45% DTI target zone. If you are under this range, and show good history of making your payment on time, you are showing responsible ability to manage your debts. You are most likely already enjoying a good credit score and will also benefit from a very good interest rate offer.

A bank's number one concern is your ability to make your payments on time. Factors like DTI and FICO score are their top tools to determining if your application meets the Fannie Mae, Freddie Mac and specific investor guidelines.

Use these simple rules to your advantage! loannetter
© copyright 2009 susan templeton loannetter

Credit Recovery after Short Sale or Foreclosure:

Position Yourself to Purchase a Home Within 2 Years After a Foreclosure Using This Strategy:

Generally, buyers who have past credit issues due to a financial crisis may be able to buy a home within three years from the incident. This varies by loan type and lender. Most lenders have their own underwriting guidelines on what they will accept and when. 620 FICO is the starting point for government insured loans. So for anyone going down this path, consider the recovery time to get your credit back into lending territory and note the recovery steps at the bottom of this post. Put them on your refrigerator! Given the sheer number of people in financial distress right now, consider that loan guidelines may change in the coming years.

For more distressed borrower information, visit our other blog: www.equitytalks.blogspot.com

How soon can you buy a home again?
If you default on your home loan now, the clock starts ticking when the home is transferred to a new lender. NOT unfortunately, the date your foreclosure is registered. If you were able to keep making your payments or miraculously did not have months of ‘late payments’ pile up on your credit you could theoretically apply for a new mortgage right away. How an underwriter views your situation is very much up to your risk factors and the lending bank’s mood (as always!).

Basically you may start considering home ownership again within three years. Some more conservative banks will say seven years because they are selling your loan to Fannie Mae or Freddie Mac. It all depends on how credit worthy you become after your loss.

Myth: "Short Sales affect your credit less than Foreclosure"
For anyone enduring months waiting for their home to successfully sell in this market; understand this: Foreclosures and Short Sales have very similar effects on your credit! 120 days of late mortgage payments (while in short sale mode = not making payments) have a very similar FICO score effect as a foreclosure. Since, on average, a short sale takes from 6 to 13 months - month after month, your credit continues to tank with each successive late; and each late is fresher and fresher piling up red marks against you (recent negative impacts have more effect on your score than older ones). Your score can only start recovering when the late payments stop and your home is sold.

In some short sale transactions -- you may also be left with a debt to pay back (the short fall the bank is owed) so be very careful about negotiating your final terms. Definitely get legal advise before you agree to any terms! Also forgiven debt is considered income by the IRS--so again get legal advise and have your accountant weigh in on this also.

Fannie Mae Guidlines are the toughest after Foreclosure:
After Foreclosure, Fannie Mae requires 7 years of good credit history and a minimum 680 FICO score, with 10% down payment and some limits on refinancing. This is after your foreclosure completion date. After a Short Sale Fannie Mae is willing to fund a home purchase in 3 years depending on hardship factors. If you filed for Bankruptcy that could easily extend your wait time a year or more. Similar caveats will apply. Expect a higher interest rate and a grilling at loan application if you expect to apply for a conventional loan.

Deed in Lieu requires 4 years recovery time from the day you walk away. If you compare the fact that a Short sale can take a year or more, a Deed in Lieu may be similar timing to a Short Sale because you are still on title with a short sale until a new buyer is found, i.e., the date the home is sold. The moment you hand over the keys in Deed in Lieu you are off title and onto recovery which may feel a lot quicker in many ways.

FHA and VA and USDA guidelines
Government lenders will often consider a home purchase for anyone with a solid credit recovery story within 2-3 years from the event, or less with some exceptions, like disability. Individual banks have their own 'overlays' on what they accept in terms of credit score and recovery times.

Essentially you could be back in a home in two years with other factors in your favor.

Private sellers may be less concerned about credit or offer a Lease to Purchase Option for those few recovery years. Just be careful and have an attorney look over ANY private sales contract. So start now to rebuild your credit!


Stick to your Recovery Strategy from DAY ONE!
1. Build an on time rental history for two years with landlords who will vouch for you
2. Maintain a stable income and work history for two years
3. Manage three active accounts responsibly (1 credit card, 1 auto payment, 1 store card or gas card)
4. Keep up to date tax records if you are self employed 
5. Put a budget in place and rebuild your credit from day one after your financial crisis has passed.
6. Work with a Mortgage Lender who will help monitor your progress.
7. Get prequalifed (by your Lender) at least three months before you start home searching in case any old issues pop up on title or your credit.

To your prosperous future! Loannetter
© copyright 2010 susan templeton loannetter

What's Your FICO Score Really Worth?

In today's market, personal credit scores are being skewed by a decline in average FICO® scores. Why should you care?

Well, if you are intending to get into debt responsibly in the coming year your FICO score is still the number one criteria your lender will use to determine your likelihood of paying them back. It's also one of the chief pricing factors to getting the best interest rate. That said, things are changing at a rapid pace. The newly minted FICO models are supposedly taking less consideration for small things like parking tickets but the really big defaults for big items like mortgages and car loans will weigh even more heavily as a result. 

All defaults have less effect on your score as time goes on. With improved history that is! So it stands to reason that if more homeowners take the 'walkaway' option the impact will be figured into the score models for that particular historical period of consumer behavior. Essentially scoring models are averages of 'good behavior'. You will notice that each Bureau has their own priority list for what is most important (to their model) and this can certainly change, which is why you have three different scores.  

According to the FICO experts at Fair Issac Company, the inventors of the FICO scoring system: a 100 point difference in your middle credit score could mean over $40,000 extra in interest payments over the life of a 30 year mortgage on a $300,000 home loan. 90% of the largest banks use your FICO® score for credit decisions. Which means 10% don't: Portfolio Lenders, some Credit Unions, Sellers and Rich Uncles don't take your credit score into consideration as their chief determining factor - at least not officially.

Rethink that 'walkaway' or other default. A foreclosure, deed in lieu or other late mortgage payment of more than 120 days  can have up to 130 -200 pts immediate negative effect on your score. Even one point below 740 can cost you a higher mortgage rate. While the effect on your score lessens over time with good behavior, the main issue such defaults present is the ability to obtain other credit, notably absolute no go periods imposed by FHA, Fannie Mae, Freddie Mac and most sane lenders. Even FHA wants to see 3 years clean credit after any major default period. And we mean clean. No 'lates' at all during that time frame. Your underwriter WILL check your rental history and they WILL check every rental landlord for the previous two year period especially if you have had a default or your score is borderline.

Conventional lenders take a hard line: Fannie Mae recently announced the new guidelines may require up to 8 years good credit history required before they will fund a conventional loan to someone who walked away from their mortgage. Traditionally a foreclosure stays on your credit report for 10 years. Bankruptcies usually fall off around 5-7 years depending on the type. Again, FHA has been more lenient to date but there are certainly other means to buy a home.

Creative financing options: So many sellers are in the game now -- you could consider a Lease/Option for a few years or Seller Financing. So really, the barriers to traditional home ownership for those with default histories suggests you find another way around your situation. And if enough people find more creative means...the banks might have to give a little! 

Get legal advice!  If you go for a seller contract on a home purchase or lease option, please be SURE and get legal advice on your Purchase and Sale contract by a neutral third party real estate attorney who is knowledgeable in this arena in your state. Seriously. We all love our Realtors and our sellers but you just can't be too informed when it comes to signing a contract for your home purchase.

All the best!
Loannetter

© copyright 2009 susan templeton loannetter

Credit Card Rates: How High the Moon?

IMPORTANT: Credit Card Rates are Rocketing!
I got one of those letters you tend to ignore the other day...a boring all legalese style thing from my credit card company. Two of them in fact. I was busy so it wound up in the inbox among the bills. A little voice told me that might be important so I finally opened one in a dull moment and read these words: "Thank you for your business".... yada yada... with some more stuff about informing you of your consumer rights and protecting your credit.... and hidden halfway down in small type this letter informed me of my new interest rate of 29.7%. I nearly feel out of my chair. I've never missed a payment on that card. I keep the balance pretty low. So what gives?

Congress passed a bill out of concern that consumer debt was getting out of control. Months ago. That bill required Big Bank's and Credit Card Companies to give us 30 days notice in writing before they could raise our interest rates and they must have a 'reason'. So what did the Credit Card companies do? They begged. They told their friends in the House Financial Services Committee and all their mates in the banking industry they could not possibly effect such a huge change and inform all their customers in so short a time (this happended like six months ago). So Congress gave your creditors until February 2010--LOTS of time to 'inform consumers' that they are raising our interest rates dramatically. Don't be surprised to see up to 30% as your new interest rate. All in time for Christmas. All in time to 'inform us' before the new congressional bill takes effect stopping them from raising our rates.

Who is being served here? Have you noticed that many of these same companies are the very banks who took our tax dollars as TARP money to keep them afloat? I am seeing more and more consumers come in with the idea in mind of paying down their debt and KEEPING it down. So now these same companies complain that consumer debt is down. Wow. 

What's a wise consumer to do? When you get the letter, call your card company and tell them you wish to OPT OUT of the increase. Which means your card will be frozen. You will have the option to pay it off and keep it open with a zero balance (for the foreseeable future) or transfer to another lower balance card. As long as you get a card that guarantees your rate beyond February 2010, that is.

Note: Don't close the credit card as that lowers your available credit. You will have to get through to a person to keep it open and opt out. The scary male voice on the recording I got says "IF YOU OPT OUT...YOUR CARD WILL BE CLOSED"...etc. So your best bet may be to pay your cards down to zero balance and just stop using them. More posts on how to work the credit system right here in the menu to the right. Just click the months to see relevant titles.
  
Happy Opting Out! Loannetter
© copyright 2009 susan templeton loannetter

FREE Consumer Credit Reports

Order your FREE credit report once a year:

Online: http://www.annualcreditreport.com/ (or download a mail-in form)
By phone: 877-322-8228
By mail: Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348

NEVER order a credit report from a site that asks you for a credit card number before giving you a 'free report'. Several firms have been convicted of secretly charging credit monitoring fees. 

The best known consumer site is http://www.myfico.com/ which is the Fair Isaac Company site (they invented credit scoring). This site has some useful credit comparison tools showing how credit scores affect interest rates which in turn affects your payments. A Tri-Merge (3 bureau) report costs about $50.00 on these sites. If you check your own credit, it does not affect your FICO score.

Be aware, you do not need to sign up for regular credit check services unless you are concerned that someone has been abusing your identitiy. If you have experienced identity theft and you are concerned that your are still at risk, you can first make a police report, then send than information to all three Bureaus and they will 'lock' your file with a PIN code so no-one can attempt to check your credit without your code and permission.

When a lender pulls your credit, it can deduct up to 3 points from your FICO score, one for each bureau. Loan shopping beyond a 10 day period can impact your score significantly by going outside the 'de-duping period', so try to confine the number of lenders you allow to pull your credit within 2 weeks. Online lending firms have been known to 'shop out' your report to several agents (who each pull your score). The last 90 day period on your report shows the credit checks that were made and by whom. A responsible mortgage broker will only submit your loan application to a qualified lender they know can fund your loan given your specific requirements. Online shopping exposes you to agents seeking 'easy targets'.

Note: Free consumer reports may not show your FICO Score. You can opt to pay a fee for that information, which lenders require. The free reports are offered once a year. I charge the actual cost of approximately $20 for a Tri-Merge report in conjunction with a loan application, which shows your score. We give you a copy and discuss any issues to be aware of. 80% of credit reports have errors on them!!

What's a good score? 300-850 is the score range, with 850 being perfect, 720 is excellent, 620 is the baseline (for lending) with under 600 being considered poor. You'll need 680 for better rates and over 720 if you are self employed for best terms. When you apply for a mortgage your lender should provide you with a copy of your report which may or may not show your score (ours do). If you are declined, they send you a notice and that allows you to mail in for a copy of the report the lender viewed.

Plan ahead! If you are considering applying for a mortgage or major loan within 3-6 months, it's a great idea to check your report to be sure everything is in order. Credit repair can be time consuming--even with sufficient proof.

What about credit repair? There are good and not so good services that act on your behalf to dispute items on your credit. (More on that in other posts). I have seen scores raised 100 pts in three months with diligent effort.

Happy scoring! Loannetter
© copyright 2009 susan templeton loannetter