Qualifying Ratios

While you may look at all of the expenses related to owning a home, lenders will look at slightly different criteria, known as qualifying ratios. Basically, they want to know what percentage of your income you will be spending on monthly payment.

The front-end ratio, or front ratio, compares your monthly pre-tax income with your house payment. Most lenders want to see a front-end ratio of 28 or lower; this means you’ll spend no more than 28 percent of your monthly gross on your mortgage.

The other ratio that lenders look at is the back-end ratio, or back ratio. This calculates how much of your pre-tax income will go toward your house payment, plus all of your other monthly debt payments—such as auto loans, credit cards, etc.

Not so long ago, a back-end ratio of 36 was the limit, but lenders have loosened their restrictions on this number somewhat.

It can be useful to figure out these numbers yourself and see if the house payment you have in mind may actually cause you undue financial risk.

You will definitely want to contact more than one potential lender, so you can compare interest rates and all the other terms associated with a loan.

To get started, you may want to research mortgages through:

• your bank or credit union;
• any of the thousands of other banks that offer mortgages;
• on-line lenders; and
• mortgage brokers.

Many consumers choose to shop through a mortgage broker, because brokers have access to loans from a range of banks.

Rather than dealing with each bank yourself, you can save time and effort—and reduce the number of inquiries that show up on your credit report—by filling out one application with a mortgage broker. A good broker will find you the best deal, given the property, your preferences and your credit score.

The broker makes his money by adding a broker premium to the cost of the loan, which he gets at a discounted rate. It’s essentially like buying anything at retail: The broker gets the loan at wholesale, then marks it up before selling it to you.

Whether you meet with your bank or a mortgage broker or go through an on-line lending service, your goal remains the same: to get a pre-approval letter before you start house hunting.

The pre-approval letter estimates how much you will be able to borrow, based on current interest rates and a quick look at your credit history. In some markets, where homes are selling quickly, your real estate agent may refuse to write an offer for you if you aren’t at least pre-qualified by a lender.

A pre-qualification letter is similar to pre-approval letter, but a “pre-qual” is nonbinding. If you’re buying in a hot real estate market, a pre-approval letter is better…and may be necessary.

Next: Working With a Loan Broker