Financing Basics For First Time Homebuyers In Texas Part 2
Equity & Income Requirements
The financier determines the pricing of home mortgage loans in two distinct ways, with both relying on the creditworthiness of the borrower. On top of checking your FICO score from the major credit bureaus, financiers will compute the loan-to-value ratio (LTV) as well as the debt-service coverage ratio (DSCR) to determine the amount they will offer you, and the interest rate.
LTV refers to the actual or implied amount of equity available in the security being borrowed against. For home purchases, the LTV is arrived at by dividing the amount of loan by the home’s purchase price. Financiers assume that the more the amount you are paying in the form of the down payment, the less the possibility of defaulting on the loan. The higher the LTV, the bigger the risk of default, and the lenders will, therefore, charge more.
The debt service coverage ratio signifies your ability to service the mortgage. Financiers divide your net monthly income by the costs of the mortgage to determine the probability of defaulting on the mortgage. Most financiers require a DSCR greater than one. The higher the ratio, the higher the probability that you will cover the borrowing costs, which means less risk to the lender. The higher the DSCR, the higher the probability of the lender negotiating the loan rate since, even at a lower rate, the lender gets a better risk-adjusted return.
As such, you should submit any kind of qualifying income when negotiating with a mortgage financier. Often, an additional part-time job or other income-generating ventures can be the difference between qualifying and failing to qualify for a loan or achieving the best possible rate.
Private Mortgage Insurance
LTV also determines whether you will need to buy private mortgage insurance (PMI). The PMI protects the financier from default by transferring some of the loan risks to a mortgage insurer. Most financiers require PMI for loans bearing an LTV higher than 80%, implying any loan where equity ownership in the home is less than 20%. The amount to be insured, as well as the mortgage plan, will determine the mortgage insurance cost and collection plan.
The majority of mortgage insurance premiums are collected monthly alongside tax and property insurance securities. Once LTV equals or is less than 78%, PMI should be eliminated automatically. You can cancel PMI as soon as the home appreciates sufficiently in value to grant you 20% equity, and a set duration has elapsed, say two years. Some financiers, such as the FHA, will evaluate the mortgage insurance as a total sum and capitalize it into the amount of loan.
There are tactics to evade PMI payment. One should not borrow more than 80% of the property value when buying a home; another way is using home equity financing or another mortgage to make up more than 20%. The commonest program is known as an 80-10-10 mortgage. The 80 represents the LTV of the first mortgage, the first 10 represents the LTV of the second mortgage, while the third 10 stands for your equity in the homeownership.
Though the second mortgage’s rate will be higher than that of the first, on a combined basis, it should not exceed the rate of a 90% LTV loan. An 80-10-10 mortgage may be less costly than paying for PMI and also enables you to hasten the payment of the second mortgage and do away with that part of the debt fast for you to pay off your home early.
Before making a decision, let one of the experts at The Texas Mortgage Pros help you find out exactly what loan is best for you. Feel free to contact us or call us today! Click here to go to the next article in this series.