Choosing the Best Mortgage

Choosing the Best Mortgage

Some old rules of thumb can help you figure how much you can afford

Choosing a mortgage used to be simple a one-kind fits all proposition. No longer. New choices are continuously being introduced. Deciding which one will work best requires that you make some guesses – how long you will live in the house or what your income will be in future years, for example.

The old rule of thumb was that you could qualify for a mortgage if you had a “housing ratio” of 28 percent or lower. Your housing ration is the percentage of your gross monthly income that you’ll need to spend on housing expenses like taxes, insurance and the mortgage itself. Your total obligation ratio should come in below 38 percent. It is the portion of your income that goes to both housing expenses and any other obligations like credit card debt, car loan and child support.

The catch is, these ratios are no longer inviolable. Some lenders have more lenient standards – a housing ratio of 33 percent, say, and a total obligation ratio of 38 percent. To find out what different lenders’ ratios are, all you have to do is ask. If you come in over 28 percent threshold in some years but not others, you might look for a “non-income verification” loan. These are designed for self-employed people, who often have a hard time showing a steady income. Bankers generally require 25 percent of the purchase price – on other loans 20 percent or even less is acceptable. Typically, non-income verification loans also have a slightly higher interest rate. You can sometimes get around the total obligation ratio simply by shifting your finances around. You might stretch out a car loan so that you have lower monthly payments.

The reason lenders are so particular about the 28 percent and 26 percent ratios is that they sell must of their loans into the secondary markets. Fannie Mae and Freddie Mae, two quasi-governmental organisations, are two of the biggest marketers of mortgages and they set the standards. A local bank of S&L might be willing to make an exception for clients who don’t confirm.

How much income you need to get a mortgage? Photograph: Megan Jorgensen (Elena).