My responsibility as a Realtor ends at the question, "are you ready?" If clients document they can afford a home, my job is complete upon finding the home that has met their requirements. However, my ethical duty as a financial housing consultant includes having the client prepared.
Preparing for financial accountability in the purchase of a home is multi-faceted; the discussion that follows is only a small portion new homebuyers should consider. However, it is also one of the most difficult areas for a client to financially overcome in the future: Debt Payments-To-Disposable Income Ratio. (DTI)
Purchasing a home has benefits. First, "I own a home!" I cannot tell you how many first-time homebuyers have given me the pleasure of watching the first-time homebuyer shuffle (literally) out of a title company's doors. It is exciting for them, and sincerely emotionally satisfying for me.
Further, homeowners enjoy tax breaks and incentives renters do not. This year, first-time homebuyers (including buyers who have purchased homes over 3 years ago) are rewarded for their home purchase by a federal return of $8,000 (or 10% of sales price) when purchasing a home. (NOTE *please see Jeff's correction regarding previous lin in the comment section) Other benefits (not an all-inclusive list) include the monthly mortgage interest and MIP/PMI being tax deductible on next year's tax returns. Further, combining your automobile with homeowner's insurance can net a 20% discount on your automobile insurance.
On the other side are the expenses homeowners enjoy. The clients are now responsible for paying their own maintenance and repairs. If clients do not have cash reserves or do not receive a home-warranty, then they must rely on other financial options to purchase these items.
Another situation that invariably occurs - " I need list." "I need blinds - appliances - furniture." Each of the statements is preceded by the word "new." These "needs" do not incorporate other true financial needs - such as savings, better health insurance, retirement funds and/or investments.
Advice, Definitions and Rules of Thumb in the Real World:
A financially responsible question you should ask yourself is "Although you can, should you?"
Sources for the following information include personal experience, the FICO, FTC, IRS, HMCO, and ICFE websites, and "My Personal Financial Planner," written by E. Thomas Garman, Virginia Tech University and Raymond E. Forge, University of Kentucky.
Installment credit: closed-ended accounts having a specified ending date and a total amount of interest to be paid. These accounts include automobile loans, bank loans, and personal loans, etc.
Revolving credit: open-ended accounts that can be paid into perpetuity and interest rates may or may not be fixed. The most prevelant kind of revolving credit are credit cards - and credit cards specifically can affect your scores in either the best or worst way.
Debt service-to-income ratio: compares your dollars spent on gross annual debt with gross annual income. Easy terminology - what you spend vs. what you make.
It is recommended, and probably required by your mortgage lendor, a client's DTI ratio be 36% or less - the lower the better. The loan originator (LO) you choose will use this ratio (as well as another ratio calculated by LO's, I will discuss at a later time) before extending credit.
Therefore, it is in your best interest to know your ratios are in-line before setting an appointment. Some mortgage lenders (because my source of information is personal experiences in Little Rock - I recommend you inquire with banks/mortgage brokers in your area) require an upfront consultation fee ranging from $25.00 up to $100.00. If the loan originator calculates your DTI above 36%, you have just wasted money.
(Note: there are other factors considered by the loan originator, but again, you want to be prepared, not ready.)
If your DTI is higher than 36%, you are probably overextended financially - and your "needs list" will not be obtainable. More importantly, after you close on your home, you may not be able to afford the necessary washer and dryer. Then, we must recalculate laundry and dry cleaning expenses - and I do not think any of you really believe in a "Fun-Wash."
While preparing your personal DTI statement and calculating your revolving accounts, use the actual monthly payments you are making, not your minimum payment. Although the bank or loan originator will use your minimal payment, it is not in your best interest to lower the payments. If you are already making payments above the minimal amount due, you have committed to paying the accounts in a more financially-efficient and responsible manner.
If this topic is of interest to you, please gather your most recent student loan documents, credit card statements, and other installment or revolving accounts, as well as utility and other monthly obligations, i.e., car insurance, daycare expenses, etc. While you are doing this, check your revolving accounts for any pre-payment penalties, as part of my next posting will include recommendations for either paying off credit cards, or lowering your amount due.
Remember, there are no quick fixes - there is no such thing as creating a new credit file - and a huge heads-up: the very last thing you want to do is to dispute items on your credit report if your goal is to purchase a home. Disputing takes the loan originator's computer generated "yes" or "no" to a manual underwrite - meaning there will be people looking at everything on your credit report in depth. Again, this is the difference between being ready and being prepared.
- Different kinds of mortgages available.
- Definitions of mortgage insurances for each kind of mortgage.
- A form for use in calculating your DTI.
- Generalized recommendations of how to lower your DTI.
- Recommendations on how to consolidate revolving accounts to save money.
Please, do not post any of your personal information in this thread - this is for your calculations.