The Basics of Financing a New Home
The funds used to purchase a home come from two sources, you and your lender. Conventional lenders have two limits on the amount of money they will provide.
- Loan-To-Value (LTV) limit. This is the amount of money the investor will lend expressed as a percentage of the house’s value. LTV varies depending on your credit and employment history, the loan program.
- Loan Amount Limit. Conforming loans cannot be higher than $333,700. Loans higher than this amount are called Jumbo loans and have different programs available than conforming loans. Conforming loans are favored by lenders as they are easily sold on the secondary mortgage market.
Mortgage interest rates usually follow the bond market and you should not find large variances in interest rates between one lender and another. Variances appear in the total cost of the loan which includes all of the fees added to the closing cost of the loan. Fees like origination fees, document review fees, and processing fees may vary widely from one lender to the next. In order to properly compare one loan offer to another you will need to have “Good Faith Estimates” from both lenders. This is the only way to compare apples to apples.
Lenders prefer borrowers that have a large down payment, income sufficient to make the monthly mortgage payments, a good credit history and credit score, and sufficient cash reserves in the event you fall on hard times.
Lenders use two ratios to evaluate your borrowing power. Your front end ratio and your back end ratio. Your front end ratio is the percentage of your income to be used for housing expenses. Your back end ratio is the percentage of your income used to pay all of you monthly reoccurring debts (like car loans, credit cards) including housing expenses.
Every lender has different ratios which they consider acceptable. Conforming loans have the guidelines of 28% front end ratio and 36% back end ratio. These ratios are only exceeded when the individual lender considers other factors which may outweigh the exceeded ratio and they believe the loan will be able to be sold on the secondary mortgage market.
Lenders can make money from borrowers in three different ways. Origination fees are fees lenders charge to setup the loan. Interest rate spread is the difference between the interest rate the lender offers you, the borrower, and the actual cost of the funds. The lender may also service the loan, in which case they earn a fixed monthly fee for sending notices and collecting payments related to the mortgage.
With many lenders you may be able to negotiate on the origination fee and interest rate spread. For example, you may be able get a loan with a 6% interest rate and pay one percentage point origination fee or get a 5.5% loan for two percentage points origination fee.