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How
Much Home Can You Afford, Adjustable Rate Mortgage Vs.
Fixed?
Did
you know that you could afford to buy a larger, more expensive home choosing an Adjustable Rate Mortgage (ARM), vs. a Fixed Rate? You
can! And
what could be more important to know right now in this bay-area real estate
market? ARM’s
have lower qualifying rates, and more lenient underwriting guidelines than fixed
rate mortgages. Assuming
all other things are equal, an underwriter is looking at two ratios. (The
underwriter makes the decision to approve your loan… sometimes with input from
your loan agent, more on that later.) Both
of the ratios are based off of your income. Yes, there are highbred loans at
higher rates that do not require you to show your income. But we’re talking
about the everyday loan that most are considering for the purchase of a new
home. The
first ratio, also referred to as the top ratio, is the total payment on your new
home divided by your total monthly gross income. The total payment on your new
home would include principal, interest,
taxes, and insurance, commonly referred to as P-I-T-I. The
second ratio, referred to as the bottom ratio, is PITI plus any other payments,
i.e., car loans, credit cards, etc., divided by your total gross income. If
you just happened to fall into the “proper” underwriting guidelines on a fixed rate mortgage, your ratios would be 33/38. But
ARM guidelines allow higher ratios, which vary from lender to
lender, but for purposes of comparison, would be about 38/45. This
means that on an ARM, the lender will allow your top ratio to be thirty-eight
percent of your total gross income, and your bottom ratio to be forty-five
percent of your total gross income. In
addition to that, remember that ARM’s have lower qualifying rates, based on
their respective indexes and margins, and currently run around 7.50%. A lower qualifying rate allows you to qualify for a higher
payment. Conversely,
qualifying rates for fixed rate loans are the actual note rate. As
an example, paying zero points, fixed rates are about 8.25%, a quarter-percent
lower in the rate if you pay a point. Now
let’s see what we can afford. Let’s
say you and your spouse’s combined total gross income is $10,000 a month.
Let’s also say your other monthly payments total $500 a month. Putting
twenty-percent down on an ARM you would qualify for a maximum purchase price of
about $550,000. But
on a fixed – just $460,000. You
already know that makes a big difference in the bay-area. Wow!
This may mean the difference of buying a home where
you want to, buying a home with another bedroom or bath, or just having cash
leftover to refurbish the home. The
scenario given is only a thumbnail sketch. Your circumstances are bound to be
different. Lending
underwriters will also weigh compensating factors. And this is where a seasoned
loan agent can really make a big difference. Not
all wholesale or retail lenders have the same loan programs. For this reason,
knowing how these compensating factors are viewed differently by various
wholesale and retail underwriters can make the difference in approving your
loan, and getting you best terms. Regardless,
it is important to evaluate these differences – with your trusted loan agent
– from the beginning. This allows you the time to explore and understand what
your options are and why. After
all, it is your loan!
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