Saturday, November 13, 2010

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:

Essentially if you are over 30% of your availble credit balance and over 40% of your monthly income going out the door via regularly scheduled debt, you are going to start seeing an impact on your ability to get a mortgage.

Use this handy evaluation tool 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.

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%. (A strong compensating factor might be your liquid assets able to service the proposed new debt.)

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!

© 2009 susan templeton

Sunday, August 22, 2010

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. 620-640 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:

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!

© 2010 susan templetonr

Monday, June 07, 2010

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!

© 2009 susan templeton