Mortgage Monday

Someone asked me to do a bit of research on payment shock and the effect on mortgage approvals. I thought it would make an interesting piece for today’s post.

The definition of a mortgage payment shock is when a new payment increases substantially over your current payment to create a “shock” to your monthly cash flow.  This can happen in several ways (these are simply examples to illustrate and not cut in stone):

• You are currently renting and are a first time homebuyer. The monthly principal, interest, taxes and insurance (PITI) on your new house will be greater than 50 percent of the rent.
• You own a condo and your monthly payment is $1,200. You are buying a house in the suburbs and your payment will go up to $2,400.
• Your current mortgage is an adjustable rate, interest only or some other type of teaser rate and has the potential to increase substantially at a later time.

Lenders will measure the risk of payment shock differently concerning the initial payment as opposed to a later payment change. The most important factor is expense vs. income ratios. In other words if your monthly debt load vs. gross monthly income is greater than 29-33%, the lender will look at the payment shock. Again, just a polite window and not cut in stone for all lenders.

In cases where payment shock is 100 percent or higher as well as with first time homebuyers, the borrower should have strong compensating factors.

Acceptable compensating factors include but are not limited to:

• A credit score of 680 or higher
• Stable employment for the past two years, demonstrating a dependable income stream
• A credit history that reflects timely repayment of credit obligations
• Potential for increased earnings as indicated by job training or education in borrower’s profession
• Demonstrated conservative attitude toward the use of credit and an ability to accumulate savings

Typically if the monthly debt to income ratios is under 30%, the lender couldn’t care if your housing payment tripled, but you get the drift. If you think you might have an overly high number, please discuss this with your lender in the beginning of the process.