HOW MUCH MORTGAGE CAN I AFFORD?

Lenders look at  ratios when they consider your application for a mortgage loan. A debt-to-income ratio is your monthly expenses compared to your monthly gross income. Lenders consider two ratios for your application:

• Monthly housing expenses as a percentage of income
• Total monthly debt as a percentage of income

Both ratios are important factors in determining whether the lender will make the loan.

Lenders usually require the PITI (principal, interest, taxes, and insurance), or your housing expenses, to be less than or equal to 28% of monthly gross income. Lenders call this the front-end ratio. In other words, if your monthly gross income is $5,000 or $60,000 annually, your mortgage payment should be $1400 or less:

$5,000 x 28% = $1400 – maximum monthly housing costs

Lenders usually require housing expenses plus long-term debt to be less than or equal to 33% to 36% of monthly gross income. Lenders call this the back-end ratio. In other words, if your monthly gross income is $5000, the combination of your mortgage, $1400, and other long-term debt should be no more than $1800:

$5000 x 36% = $1800 – maximum total debt

If your debt-to-income exceeds these ratios, talk to your lender about your options.  Some lenders allow up to a 41% back end ratio.

BASIC MORTGAGE OPTIONS

15-YEAR MORTGAGE

• Lower interest rate
• Build equity faster
• Less interest to pay
• Larger monthly payment

30-YEAR MORTGAGE

• Higher interest rate
• Build equity slower
• Can deduct more interest
• Lower monthly payment

FIXED RATE

• Interest rate stays the same for the term of the loan
• Interest rates could go down while you are locked into your mortgage at a higher than market rate

VARIABLE RATE

• Interest rate can increase or decrease during the term of the loan
• You might have a low rate for an three, five, seven, or ten years
• Monthly payments can be lower than fixed rate loans

BALLOON MORTGAGE

• A loan that has level monthly payments that will amortize it over a stated term (e.g., 30 years)
• Requires a lump sum payment of the remaining principal balance at the end of a shorter term (e.g., 10 years)
• Interest rate stays the same for the term of the loan

QUESTIONS AND CONSIDERATIONS TO USE WHEN CHOOSING A LENDER

HOMEBUYER ASSISTANCE PROGRAMS

There are a number of different programs available for first-time homebuyers. The following are just a few examples of the programs available.

FEDERAL HOUSING ADMINISTRATION (FHA) INSURED LOANS

The 203(b) is the most common FHA loan, featuring:

• Low down payment
• Flexible qualifying guidelines
• Limited lender fees
• Maximum loan amounts

DEPARTMENT OF VETERANS ADMINISTRATION (VA) INSURED LOANS

Features of VA loans include:

• You must be an eligible veteran
• There are no down payment requirements
• Competitive and negotiable fixed interest rates
• Limitations on closing costs
• Longer payment terms

Wow! I can’t believe it. 15 months after the incident, the City of Chicago is going to pay me $173 for my tire that blew out on a giant pothole which was cleverly placed on a highway exit ramp.

As I mentioned in a previous post, there are ways to submit claims to the City of Chicago for damage sustained from one of the many potholes decorating our streets. I had tried this back in March of 2008 but basically gave up any hope of recovering my loss after waiting months for a response. Well…the response came in the mail yesterday:

“the Committte on Finance hereby offers the sum of $173.00 to settle the above-captioned claim. Final settlement is subject to City Council approval.”

Geez. Chicago is going to hold a city council meeting to discuss my pothole claim.

I guess if you can’t fix the potholes you can always pay for the damage.

Although we currently have an administration in Washington that is determined to micro-manage the economy the data is already proving that it’s just not possible.  Markets are stronger than governments and going against the market is like building cities below sea level in the path of hurricanes. The water always gets in. (In fact, the Dutch have recently decided to relinquish many of their low lying areas to the sea.) For instance, there are numerous examples of governments attempting to manipulate their currencies but in the end George Soros and the markets always win.

So it is with mortgage rates. The government attempted to drive down mortgage rates and other interest rates by buying all manner of bonds, and for a while it worked. However, recently the levies are starting to leak. Check out what has happened to 30 year mortgage rates in the last couple of weeks:

You can see the same pattern in the interest rate on the 10 year government bond:

For a while the interest rate on these government bonds was driven down as investors sought safety, but not any more.

There are a few things going on here and not many of them are good for the housing market. First, the US just has too much debt – too much personal debt, too much government debt, and too much financial leverage – and our creditors have taken note. There is even talk of a downgrade of the credit rating of the US government. All this translates into a higher risk premium for US debt and that means higher interest rates.

The second issue is that in creating huge amounts of money in order to manipulate the market the US government has created inflation fears. Consequently, the dollar has taken a nose dive and with it the price of oil and other commodities have taken off. To get an idea of what is going on with the dollar just look at this chart of the dollar priced in Euros:

Inflationary fears and a weaker dollar (two sides of the same coin) mean that investors need higher interest rates to hold US dollar denominated investments.

So I think higher mortgage rates are going to be the reality – and they’re currently no higher than they’ve been on average over the last 5 years and they are significantly lower than they have been in the past 20 years. So there is still plenty of upside (or downside depending upon your perspective) in mortgage rates. And if inflation really materializes watch out.

There is one potential silver lining in all this – and one can’t help but wonder if this isn’t actually the government’s secret intention. If inflation takes off then we can all pay back our debt with cheaper dollars down the road. The debt stays constant but we all eventually start making more money, even though the money is worth less. It’s one way to work ourselves out of debt.

Of course, for those of us that don’t have a lot of debt and in fact have lent money, it’s not so good. But eventually, in an inflationary environment, housing prices take off and that will bail out a lot of people who are upside down on their mortgages – unless of course interest rates are so high that no one can afford to buy these higher priced homes, in which case maybe home prices don’t go quite that high. I guess we’ll just have to wait and see how all these forces net out. I’m betting that the force of the government will prove to be nil in this equation.

I’ve read many stories about how we got into the current financial crisis. However, there is a series that Ira Glass is producing for NPR’s This American Life that tells the story in much more understandable, insightful, and entertaining terms than I’ve seen anywhere else. I would encourage you to check out the following programs, which you can either download as transcripts or you can stream them to your computer:

The Giant Pool Of Money – May 9, 2008

This Peabody Award winning show explains how Wall Street and homeowners are connected by a chain of middlemen and tap into a giant global pool of money and how this setup led to the current crisis.

The Watchmen – June 5, 2009

Who was minding the store when all this was going on? This show is very interesting in that it connects events that took place in the 1930s with today’s events and it becomes clear that for every fix the government can come up with there are eventually unintended consequences down the road.

There is a too-often ignored field in the MLS for condos which is abbreviated in the system as POO – percent owner occupied. In the current environment this number has become critical for buyers seeking mortgages since lenders see a low number – less than 70% – as a sign of trouble. In other words, a building with lots of POO is a good thing.

Unfortunately, as I alluded at the beginning, this field is rarely filled in by the listing agent. So, what happens? Buyer and seller enter into a condo sales contract and when buyer tries to get a mortgage the mortgage company balks and the buyer has to get another mortgage – except now mortgage rates have risen and the buyer’s cost goes up. Worse yet, the deal falls through.

The implications are clear for both buyers and sellers of condos. If you are buying a condo you have to know if you have enough POO before you pick your lender because, given your down payment, not all lenders will be willing to lend. According to Tom Fishwick of Guaranteed Rate, you will certainly have an easier time getting a mortgage on a low POO building if your down payment is at least 20% because then some lenders only require a limited review of the condo building and don’t even ask how much POO you have. “The reason you would have trouble getting a loan approved without 20% down is because the Mortgage insurance companies may not insure the loan. Lenders are willing to lend up to 90% but they require mortgage insurance and it is those guidelines that have been changing.” Curiously, an FHA loan, with only 3.5% down, will allow up to 49% renters in a building. Of course, you pay a higher effective total rate for an FHA loan.

If you are selling a condo in a low POO building then you better line up a lender who will be willing to finance the purchase and make sure any potential buyer can qualify for their program. Alternatively, you can sell your condo 3 times before a deal actually takes.

Just to give you an idea of how serious this problem can be consider Millenium Centre at 33 W. Ontario in Chicago. This building has some $1 MM + condos/townhomes in it. It also has 63% renters or 37% POO. (As a side note, this is an American Invsco building and they often actually assisted investors in buying and renting units in their buildings.) You have to wonder if the low POO is contributing to all the problems in that building. Aside from the fact that many lenders wouldn’t touch that building, I would personally be afraid to put a buyer there. Of course, I would be extremely cautious about any building in the South Loop. Just walking through some of them you can tell that they don’t have a lot of POO. And as I recently learned, even nice buildings in the West Loop might have too many renters for some lenders.