At the risk of loosing about 51% of my readers, I have to say right up front that... No, girls! This is not about the 1983 movie, "Risky Business," that propelled Tom Cruise to fame. Sorry!
This is the third in a series of articles on mortgage lending in the Covington Georgia real estate market. And that, too, in today's market, can be a "risky business."
In mortgage transactions, the lender takes the risk that you and I, as borrowers, may default on the loan and not repay the debt. Therefore, they assess their risk on every type of mortgage loan to determine whether the loan should be approved or declined. There are four major risk factors lenders consider today when underwriting a mortgage loan in the Covington real estate market and several lesser ones. In this part of the series, we'll look at the first two major factors, LTV and DTI. In Part 4, we'll look at the other two major risk factors and the lesser ones.
Loan To Value (LTV)
One of the first risk indicators lenders look at is called the Loan To Value (LTV) ratio. Loan To Value is a mathematical calculation in which the amount of the loan you're applying for is divided by the lower of either the purchase price or the appraised value of the home you are buying.
Example:
- Purchase Price of $200,000
- Appraised Value of $203,000
- Down Payment of $20,000
- Loan Amount of $180,000
$180,000 divided by $200,000 = 90% LTV
The normal maximum LTV expected by the lender for a "conforming" mortgage loan for a primary residence or second home is 95%. That is to say that the borrower pays 5% down, leaving a mortgage loan of 95% of the sales price of the home being purchased.
Normal maximum LTV for a conforming mortgage loan on investment property is 90% (10% down payment).
Loan options are also available for LTVs between 95% and 100% even though they represent a higher risk to the lender. They are available on some special conforming programs and on government guaranteed programs through the FHA and VA.
There is a 95% maximum LTV on home refinancing to obtain a better interest rate, and 90% maximum LTV on refinancing for home equity loans, called "cash out refinances."
When a borrower is obtaining two mortgage loans to finance a home (such as an 80/20 loan - 80% first mortgage, 20% second mortgage), the mortgage lender considers a calculation called the CLTV or Combined LTV.
Example:
- Purchase Price of $200,000
- Appraised Value of $203,000
- Down Payment of $20,000
- 1st Lien Loan Amount of $160,000
- 2nd Lien Loan Amount of $20,000
$160,000 divided by $200,000 = 80% LTV
$160,000 + $20,000 = $180,000 divided by $200,000 = 90% CLTV
Debt To Income Ratio (DTI)
The second major risk factor lenders consider is your Debt To Income Ratio (DTI). Making up your DTI are two ratios: 1. Housing Ratio, and 2. Total Debt Ratio.
The Housing Ratio is the monthly estimated house payment (including PITI: principal, interest, property tax and homeowner's insurance) divided by the borrower's and co-borrower's monthly gross income (before tax).
Example:
- PITI of $1,420.50
- Gross Monthly Income of $6,000
$1,420.50 divided by $6,000.00 = 23.7% Housing Ratio
[TIP] A good rule of thumb to use when you're crunching numbers before deciding about applying for a mortgage loan is to make sure your Housing Ratio is no higher than 30%. In reverse, that means that you should be able to comfortably afford a house payment (PITI) amounting to about 30% of your gross income.
The Total Debt Ratio is the estimated monthly house payment (PITI) plus other monthly payments such as car loans, credit cards, personal loans, etc., divided by the borrower's and co-borrower's monthly gross income.
Example:
- PITI of $1,420.50
- Other Debt
-
- Auto Loan Payment $460.00
- Credit Card Payments Totaling $300.00
- Gross Monthly Income of $6,000
$1,420.50 + $460.00 + $300.00 = $2,180.50
$2,180.50 divided by $6,000 = 36.3% Total Debt Ratio
[TIP] A good rule of thumb to use for a maximum Total Debt Ratio is no higher than 40%.
[TIP] Your car loan payment is not normally considered when figuring your Total Debt Ratio if you have less than 10 months left to pay on the loan!
Most loans today are underwritten through automated (computerized) underwriting. When lenders use automated underwriting, actual maximum ratios allowed may be different since the computer can easily consider all risk factors of the loan at once. The ratios can go higher than 30% Housing Ratio and 40% Total Debt Ration. However, when you're crunching numbers yourself, as I mentioned above, it's best to use 30% Housing Ration and 40% Total Debt Ratio as guidelines.
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Copyright 2008 by Your Traditional Neighborhood Specialists. All Rights Reserved. All information provided in Covington Living Blog is subject to change without notice, and represents the ideas and opinions of the author(s). The author(s) are not responsible in any way for the accuracy of the information provided, and offer no warranties of any kind, either express or implied.
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