Mortgage 101: Just the Basics
Qualifying for a mortgage all comes down to the numbers. Lenders grant loans based on risk scores, such as FICO scores, and ratios.
What is a FICO score? It is a rating, on a scale of 300-800, used to determine your loan ability. A FICO score of 400 indicates that you may have had trouble in the past paying your bills. Thus, a bank is less willing to provide a loan to someone with a score of 400 because it is considered high risk. On the other hand, a FICO score of 700 is great. This type of FICO score will ensure all types of happy grams in the mail from potential creditors begging for you to become one of their victims. It indicates that when you create debt, you pay it back either before or on time regularly. Thus, a bank would love to loan to someone with this type of score, of course contingent upon all other factors falling into place, ie a savings, a job, current taxes.
RatiosWhat are ratios? When assessing whether to loan money to you or not, lenders will use various factors to determine just how risky it is to loan money to you. One of those factors is ratios. They will determine a front end ratio and a back end ratio.
- Front End Ratio - This ratio is based on your gross income. Some really smart person a long time ago said if you are giving more than "x" percent of your income to your mortgage, you will eventually wind up burden with debt and unable to pay your bills and buy your kids "G.I. Joe with the Kung Fu grip" (only those born before 1978 will be able to understand the latter part of that sentence) So, in order to decrease the amount of risk that the bank will have to foreclose on your house or incur debt by loaning to you, it was determine that no more than "x" of your gross income should go to your mortgage, taxes, and insurance, also know as PITI.
- Back End Ratio - this ratio basically says, your PITI plus monthly bills cannot amount to more that a certain percentage of your gross income (probably created by the same smart person). Essentially, it goes like this, "ok Mr./Ms. Customer, with an income of "x", your mortgage, taxes and insurance plus you monthly bills cannot be more than "this dollar amount". Based on our calculation of your ration we will loan no more than this amount to you".
Types of Mortgages
Conventional, Conventional Loans, though not so conventional anymore, is the basic type of loan. Base parameters will be a certain FICO is needed, at least 5% down, two months savings equal to your PITI estimate and front and back end ratios of 28/36, respectively.
What does all of that mean? It means that no more that 28% (give or take a smidget) should be attributed to your mortgage payment (PITI) and your PITI plus your monthly bills cannot amount to more than 36%. Too much more than ratios of 28/36 puts you in the range of high risk for affordability and will thereby decrease your chances of getting a loan for a mortgage. There are circumstances in which those ratios can be increased, but that will not be a part of this briefing.
FHA, Another smart person said, "well, what about those people out there that will not fit perfectly into the box of requirements set by a conventional loans? There has to be another way that they can realize a piece of the American Dream too". Boom! FHA loans were created. FHA loans are not specifically FICO score driven and provides a way of forgiveness to those that may have slip in credit ratings for reason beyond their control and reason within their control. The ratios are slightly expanded and allow for non-squeaky clean credit and low debt. The ratios are 31/43 with similar requirements of Conventional loans.
VA, These types of loans are geared to assisting veterans with home ownership. Ratios hover around 0/41. Yes, the front end ratio is 0% along with no money down.