January 23, 2018

Prequalification: Focus on Payment, Not Price

By J. Mansisidor

If a lender tells you that you’re prequalified for a $275,000 purchase, then you’re qualified to buy any $275,000 property that you desire, right? When you talk with lenders, you want to ask about the maximum purchase price that you qualify for, don’t you? After all, what you want to know is how much house you can afford – even if you plan to purchase below that limit. Isn’t that the bottom line?

The answers are: no, No, and NO! Here’s why.  
Imagine a borrower is graduating from medical school and beginning a residency with an annual salary of $55,000, or about $4,583 per month. Let’s suppose that this individual has about $325 per month in total liabilities – payments on a car, credit cards, and so forth. Now let’s assume that the borrower gets a 30-year fixed mortgage at 3.875% for the $275,000 purchase – the monthly payment for principal and interest will be about $1,293. At this point, total monthly liabilities are $1,618, and the borrower’s debt-to-income ratio (monthly liabilities divided by monthly income) is only a bit over 35%. Not bad.

But, there’s homeowner’s insurance that must be considered – let’s suppose it costs $75 per month. Now the debt-to-income ratio (DTI) is almost 37%. Still, not too bad. And there are real estate taxes, and those are $100 per month. Still not terrible, but notice how the DTI has crept up to slightly over 39% at this point.  Assume that a lender allows up to a 45% DTI; you can make a full price offer on that $275,000 home you just saw, right? Maybe. What if it is a condominium with $300 monthly dues?  In that case, your DTI just jumped to almost 45.7%, and you no longer qualify. The same thing can happen with Homeowners’ Association (HOA) fees. Sometimes real estate taxes can have the same result, especially in high-mileage areas, or when you’re dealing with homes that are priced well below assessed value. Also find out if your future home is going to be in a flood zone when shopping for home owner’s insurance.  This can be an immediate deal breaker, especially if your debt ratio is tight to begin with.

This scenario may seem contrived, but in truth it is not.  Condo or HOA fees can be deal-breakers, and real estate taxes – which vary tremendously by locale – can be deal-breakers, too. Sometimes, a home that appears to be within the budget and within your lender’s DTI limits turns out not to be within those limits once you factor in taxes, insurance, and association fees.

So, when you talk with lenders, you of course want to get an idea of the price range that defines the upper limit of your purchase. It’s useful to have a rough number in mind as you go house hunting.  But be sure to focus on the total monthly payment, not merely the price of the property, because ultimately it is the total payment – not the sale price of the home — that determines your DTI and whether you qualify for that particular purchase.

J. Mansisidor is a Senior Loan Officer with Fulton Mortgage Company, a division of Fulton Bank, NA.  www.fultonmortgagecompany.com