- The Washington Times - Wednesday, October 18, 2006

Last week we considered the impractical notion that a first-time home buyer can receive accurate rate and closing-cost quotes without giving the lender any information about the purchase or down payment. The bottom line is that a first-time home buyer needs to provide some details to the loan officer in order to receive an accurate quote.

This week, I would like to illustrate the importance of consulting with a competent loan officer before house hunting begins. Here’s a description of a conversation I had this week.

A young man was referred to me by his real estate agent. He says he needs to be pre-approved for a mortgage and is planning on going out this Sunday to look at houses. I ask him a few questions and learn that he’s married, has $110,000 in combined annual income, $65,000 in the bank and a $400 monthly car loan payment.

With this information, I certainly can qualify him and his wife for a particular mortgage amount, but I don’t do it that way. If you have good credit, you can find a lender that will lend you almost any amount of money. Borrowing an amount of money just because you “qualify” in the lender’s eyes is the wrong approach.

Therefore, I ask this fellow a few more questions. I learn that he and his wife are renting an apartment for $1,100 per month. I ask him if they have discussed a “comfort level” for a total house payment. He tells me they are hoping to keep their payment below $2,500 per month. He then tells me that he’s going to be visiting houses in the $500,000 range.

I know immediately that this scenario might be tough. I run the numbers to determine the traditional “qualifying ratios” used by most lenders. I multiply their combined monthly income of $9,167 by 38 percent and get $3,483. Lenders use the 38 percent guideline as the maximum amount for total house payment and other monthly obligations, including car loans and credit card payments.

I then subtract the $400 car payment and get $3,083. This is the maximum amount that most lenders would consider to be a reasonable house payment based on their circumstances.

I tell the young man that his goal of keeping the payment under $2,500 is well under traditional guidelines. This is a good thing, but can he purchase a $500,000 house and keep the payment to $2,500? Let’s find out.

Because they have $65,000 in the bank, I create a scenario using a 10 percent down payment. A 90 percent loan would require private mortgage insurance, so we have to break the borrowed money in to two loans, called an 80-10-10 scenario. An 80 percent loan on a $500,000 purchase results in a first-trust loan of $400,000. Using a market rate of 6 percent for a 30-year fixed-rate loan, I see the principal and interest (P&I;) payment is $2,398 per month.

The remaining 10 percent ($50,000) to be financed will carry a rate of about 7 percent, resulting in a P&I; payment of $332 per month.

Add estimated taxes and insurance of $400, and we have a total payment of $3,130.

I tell my borrower that he can certainly afford a $500,000 house in the eyes of most lenders, but the monthly payment will be far more than the $2,500 comfort level he and his wife have set. They can’t have their cake and eat it, too. They have to give up something.

I then calculate a purchase price based upon their $2,500 comfort level and give him the unfortunate news that he and his wife would have to lower their purchase-price range to about $400,000.

The disappointment is evident over the telephone, so I suggest a few options. First, I explain the tax advantages of homeownership versus renting. I explain that nearly $30,000 of their annual interest and tax expense will be deductible. This is $20,000 more than the $10,000 allowable standard deduction. The $20,000 equates to roughly $6,000 in tax savings, effectively freeing up $500 per month.

Bingo. Assuming that no major changes enter their financial picture, this couple can collectively withhold $500 less from their combined paychecks and apply it to a larger mortgage payment without being in danger of underwithholding and facing a big tax bill in April.

I advise my borrower that I am not a tax adviser and he should speak with one in order to fine-tune the numbers I have given him.

I then explain to him that there other options. The oft-demonized “interest-only” loans will enable the couple to borrow roughly 18 percent more with the same payment. I explain that an interest-only loan is available with a fixed interest rate, eliminating any possible increases. I also explain that an interest-only loan does not require an interest-only payment. Principal curtailment can be made at any time, and interest-only loans are perfectly acceptable programs for those folks who are financially responsible.

In the end, my borrower was armed with scenarios with a purchase price range between $400,000 and $500,000. As he and his wife visit homes this Sunday, they will have a reasonably accurate picture of what each house will cost them.

House hunting without this knowledge is a waste of time. Consult a competent loan officer and educate yourself before the house hunt.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).

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