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Has Your Credit Changed?

  by Peter G. Miller

It's a combination car, pick-up truck, and SUV. You really want it. The features are great, the style is the latest, and it's affordable -- after the down payment the cost is only $300 a month.

"Would you buy this car today if I can include the genuine wood grain, rubberized, side moldings?" asks the salesman.

Before emitting a strong "yes" stop and consider what's about to happen. You will be increasing your debt load and monthly payments, things which make mortgage lenders edgy. If you want to buy a home in the coming months, you need to carefully consider your financial choices.

The issue here is not cars. If you need a car for safe travel, then safety comes first. But if you merely want a new car -- or super-duper music system, an antique guitar, a trip abroad, or anything else that increases your monthly costs and is not absolutely and unquestionably necessary, then you should think about mortgages, debt, and ratios.

Lenders don't like risk. A lender's view of financial perfection means making loans to borrowers who always pay their mortgages. Alas, some people don't re-pay, so lenders need to limit their risk. They do this by checking the value of the house with an appraisal and by assuring that borrowers are well-qualified.

The expression "well qualified" as lenders use the term means something more than finding borrowers with good incomes. Yes, lenders want sufficient income for any level of borrowing, but they also want something more, a sense that borrowers are not burdened with too many bills. To lenders, this means limiting debt and monthly costs.

Lenders typically qualify borrowers on the basis of two measures: front ratios and back ratios. In general terms, these standards work like this:

The "front ratio" is the percent of your gross monthly income used for mortgage principal, mortgage interest, property taxes, and property insurance. Depending on the loan program, lenders might allow 28 to 41 percent of a borrower's income for "PITI."

The "back ratio" includes PITI plus car payments, student loan payments, credit card payments, auto loan payments, etc. Back ratios typically range from 36 to 41 percent, but can be greater.

Let's say you want to borrow $150,000 at 7 percent over 30 years. The monthly cost for principal and interest is $997.95. Let's also say that the monthly cost for taxes and insurance is $250. The total for PITI is $1,247.95. If a lender will only allow 28 percent of your income for PITI, it means you must earn at least $4,457 before taxes each month.

If the lender allows 36 percent of your income for the back ratio, then if you earn $4,457 month as much as $1,605 is available for housing costs and other monthly debt. Since $1,247 is already committed to PITI, $358 remains for installment loans, credit card debt, and such. ($1,605 less $1,247 = $358).

You see the problem. That nice, shiny car will increase your monthly debt load to the point where you may not qualify for a $150,000 mortgage.

What to do?

Defer major expenses until after you have closed on your home.

Do not apply for a mortgage, obtain approval, and then take on more credit or installment debt before closing. Lenders re-check credit reports just before settlement. If they see new and unacceptable levels of debt, the mortgage may be declined.

Obtain a smaller mortgage by purchasing a less expensive home or by paying more cash up front.

Pay down other consumer debt to reduce monthly payments.

Consolidate bills to obtain lower monthly costs -- but be wary of long-term expenses and transfer fees.

When possible, switch from high-cost credit cards to lower-cost cards with smaller monthly costs. Be wary of higher future rates and transfer costs.

Look for mortgage programs with more liberal qualification standards. If you have a strong credit history such financing should be readily available.

Ask if lenders can consider "compensating factors" which may allow you to borrow more.

For details, have brokers and lenders review credit options and qualification standards -- and keep monthly credit payments as low as possible.

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