As this video explains, Federal laws put into effect in 2014 and supervised by the Consumer Financial Protection Bureau define lending practices and loan terms for a new category called “Qualified Mortgages.”
They provide stable loan features for consumers and improve legal protection for lenders who follow the guidelines.
These guidelines require lenders to assess each borrower’s ability to repay their mortgage loan.
As of 2014, guidelines require that a borrower’s monthly DEBT – including mortgage – be no higher than 43% of their monthly gross INCOME
The laws also define unacceptable loan terms:
- interest-only loans
- terms over 30 years
- negative-amortization loans that increase principal over time
- most balloon loans
do not meet the Qualified Mortgage guidelines.
The laws aim to provide consumers with objective guidance about reasonable debt from the CFPB and in return, to grant lenders who follow that guidance with higher levels of protection from lawsuits.
Ask your lender about Qualified Mortgage options for your home purchase.
Measuring your existing debts against your existing income is one part of a lender’s required assessment of your ability to repay a loan.
Like the video says: debts are existing financial commitments; a car payment is a debt a grocery bill is not.
To calculate your debt-to-income ratio add up your monthly debt payments and divide them by your GROSS monthly income. (Gross income is generally the amount of money you earn BEFORE taxes and other deductions.) The Federally-established debt-to-income target is a maximum of 43% for Qualified Mortgages.
If your ratio is higher there may be other loans available – however, there may also be additional questions to establish your ability to repay, and the rates may be different than those available for Qualified Mortgages.
Studies suggest that a high debt-to-income ratio puts a homeowner at greater risk of challenges making monthly payments. So consider your situation and risks carefully before exceeding that suggested ratio.
What are the “Ability to repay” rules about?
In a nutshell, as this video shows, new laws require lenders to make a good-faith assessment of a borrower’s capacity to pay back their loan over time.
It’s a longer-term view that goes beyond immediate income, debt and credit rating.
These new Federal laws- supervised by the CFPB – require lenders to ask more questions –
about income, assets, employment, credit history, and monthly expenses –
as they relate to the proposed loan.
For example, a lender offering a mortgage with a low initial rate must try to assess how a borrower will handle the later, higher rate as well.
If you’re applying to borrow ask whether the program you’re considering is a Qualified Mortgage
Ability-to-repay rules are built in to loans that meet Qualified Mortgage guidelines.
Equity is the value YOU own in property such as a house. It’s the difference between what’s OWED and what the property is WORTH in the current market.
The example this video shows – you have a house worth $300,000 today and you owe the bank $200,000. Your equity would be $100,000.
If the house is valued at $500,000 in five years, and you still owe $150,000 your equity will be $350,000.
Equity grows if the property value goes up or if the amount owed goes down. The key thing to remember, simple as it sounds, is that you “own” increases in value. The bank’s loan doesn’t go up if the home’s value goes up.
Equity in a home can be used as collateral for loans but a house is not a piggy bank. Home equity can become a key financial asset over time; treat it wisely.
The Prime Lending Rate – sometimes just called “Prime” – is the interest rate that banks charge each other for overnight loans. Some consumer rates – like ARMs – are set in relation to Prime.
In the US, Prime is affected by the Federal Reserve lending rate to banks; historically, Prime is about 3 percent above the Fed rate.
The video shows an example.
- The Federal Reserve loans to Bank A at 1%
- Bank A loans to Bank B at 4%
- Both banks – A & B – will recalculate variable-rate loans like ARMs on that 4% Prime figure.
ARM rates are frequently defined as “% above Prime” – that gap is usually called the “margin” or “spread.” Just remember those 3 layers in Prime: Federal Reserve Bank A Bank B And finally, YOUR rate.
Discount points allow you to lower your interest rate. While this video simplifies things to help you remember, “points” are essentially prepaid interest with each point equaling 1% of the total loan amount.
Generally, for each point paid on a 30-year mortgage the interest rate is reduced by 1/8 (or.125) of a percentage point.
When shopping for loans, ask lenders for an interest rate with 0 points and then see how much the rate decreases with each point paid.
Discount points are smart if you plan to stay in a home for some time since they can lower the monthly loan payment.
Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay for some of them.
Usually, Yes. Like the guy in the video says, by sending in extra money each month or making an extra payment at the end of the year you can accelerate the process of paying off the loan.
When you send extra money, be sure to indicate that the excess payment is to be applied to the principal and keep records.
Remember that payment applied to loan principal is not tax-deductible. Most lenders allow loan prepayment, but some loans may have prepayment penalties.
Ask your lender for details.
While this video simplifies things to help you remember, the loan to value ratio is the amount of money you borrow compared with the price or appraised value of the home you are purchasing.
Each loan has a specific LTV limit. For example: With a 75% LTV loan on a home priced at $100,000 you could borrow up to $75,000 (75% of $100,000) and would have to pay $25000 as a down payment.
The LTV ratio reflects the amount of equity borrowers have in their homes. The higher the LTV the less cash homebuyers are required to pay out of their own funds.
So, to protect lenders against potential loss in case of default, higher LTV loans (80% or more) usually require mortgage insurance policies.
There are mortgage options now available that only require a down payment of 5% or less of the purchase price. You’ll see some pictures in this video to help you remember later – the larger the down payment, the less you have to borrow and the more equity you’ll have.
Mortgages with less than a 20% down payment generally require a mortgage insurance policy to secure the loan.
When considering the size of your down payment consider that you’ll also need money for closing costs moving expenses, and – possibly – repairs and decorating.
The monthly mortgage payment mainly pays off principal and interest. But most lenders also include local real estate taxes homeowner’s insurance, and mortgage insurance, if applicable.
If you are refinancing compare what is and isn’t included in your financing options. Watch this video and it’ll make sense.