I was recently fortunate enough to have the opportunity to interview Dale Siegel, author of The New Rules for Mortgages. We exchanged emails in a Q&A format on the subject of mortgages, the housing market, etc. Here are her responses to my questions.
Frugal Dad: Lenders used to operate under a 28/36 mortgage-to-income/debt-to-income ratio when calculating maximum mortgage eligibility. How has the housing bubble affected those ratios for lenders?
Dale: Lenders use ratios as guidelines for qualifying a borrower for a mortgage. It is the total housing expense divided by gross monthly income and then total housing expenses plus all monthly debt divided by gross monthly income. Depending on which lender you go to, the typical ratio that lenders work with can range from 28/36 to 33/41.
Before the implosion of the mortgage industry, many lenders would push ratios upwards of 65% of the borrower’s gross (before taxes) monthly income, using compensating factors such as good credit or low loan to value. There were also products such as no income and no ratio loans which would eliminate the calculation all together and a borrower could mortgage multiple amounts of monthly income- and are behind the eight ball now!
Ratios are a guidance tool for the lender to calculate what they think a borrower should take out. However, the true number comes from the borrower themselves. Use the mortgage amount the lender tells you you qualify for and really analyze it based on what you know about your own finances. Make lists of your monthly income and expenses, create a 5 year plan and see what larges expenses might be coming up in the short term and think about things in life that can mess up your plans. Only the actual borrower knows what they can comfortably afford for a housing expense without compromising too much. Remember, the lender does not take into consideration things such as food, clothing and summer camp-but you should-and you can’t have it all.
Frugal Dad: How much (%) should homeowners aim to put down on a mortgage to secure the most favorable terms?
Dale: Down payments should be as large as you can manage: no money or little down mortgages are history-except for the FHA. Two years ago, you could get the same interest rate with 5% as you could with 25% down. Now, the lenders use a matrix consisting of FICO score and loan to value to calculate the interest rate. So, the better your FICO score, the lower your interest rate and the more equity you have in a home the lower your interest rate.
Many lenders will not allow loans over 80% now and it is harder to get PMI (Private Mortgage Insurance) for those loans. The lenders charge higher rates for scores over 620 and for loan to values over 60%. So if your credit score is 640 and you are putting down 20% your rate will be much higher than the guy that has a 720 FICO score and is putting down 30%. This is the way all lenders work now and they all go off of the same chart. So, one bank will not be better than another in this instance. What the borrower needs to understand is how the lender calculates their interest rate and they have the right to ask for the actual computation used.
Frugal Dad: To qualify for the best mortgage rates, what credit score range should home buyers aim to be in?
Dale: The credit score is more important than ever now, because the lenders go off of the pricing matrix and there are no longer compensating factors used to cover a bad credit score. The score is what it is with no deviation in pricing the mortgage interest rate. As said, the lenders would do a loan with a FICO score of 500 if the borrower had other things going for them such as low loan to value, little debt or a lot of assets in the bank after the closing. Now, those things do not matter.
Most lenders will not take a loan with a FICO score under 620 and the new “good” score is currently 720. So, if your score is not over 720 you can still get a loan, as long it is not under 620-you will simply pay a higher rate. Of course there are lenders out there that will budge on that, but be careful which promises you follow.
Shopping for a Mortgage
Frugal Dad: Where is the best place to shop a mortgage for first-time home buyers? Current bank? Mortgage broker? Online?
Dale: The other day I was misquoted in the Tribune as saying do not use a mortgage broker to shop for a loan. I received hate mail from a bunch of Texas mortgage brokers and had to convince them that, being a mortgage broker myself, I did not specifically say that. What I did say was that the consumer needs to take responsibility for themselves and shop for a loan with the best interest rate themselves. I truly believe that no one is too busy, too important or too dumb to put their financial future in the hands of one person and must always be checking the information provided to them. (Think if Bernie Madoff was also providing mortgages to his chosen clients.)
When shopping for a loan, one should never use the internet as more than an educational tool. The internet is a fabulous world for loan terminology and mortgage calculators, but why would you get a mortgage from a provider that you found in cyberspace? Companies such as Lending Tree, Quicken Loans and others, are more so lead generating companies for the mortgage industry rather than direct providers. Remember free credit reports and loan qualifications come with a price tag. This price being your information is being sold to a loan officer somewhere that will hound you to get your mortgage through them.
So, now that I have told you where you should not get a loan, where should you go to get a mortgage? There are the commercial banks, such as Bank of America, Wells Fargo and the like. They are great big institutions which have lots of loans to choose from and competitive interest rates. What they also have are departmentalized loan processing systems and voicemail. So, if you have the patience to call around, shop for a rate and deal with many different people through the loan process then a large bank would be for you. Next, we have the smaller regional community banks known as savings and loans. They work just like the big banks do, but you might get more personalized service. Again, shop around and ask a lot of questions.
Third party mortgage providers are mortgage bankers and brokers-like me. Having assisted with over 65% of all mortgages obtained over the past five years, they were a big part of the real estate boom and bust that we have seen. These companies are not the direct lenders and simply provide a service of assisting the consumer with getting a mortgage with hopefully the lowest interest rate. Their job is to shop your loan and work with you and all the parties involved from beginning to end. For this, they receive a fee from the lender your mortgage ultimately goes to. It is a win-win for all if you are working with a professional and honest broker.
The fact is that no matter what institution you get your loan from it is the loan officer you choose that should be the big decision. I believe it does not matter where I work, whether a bank or a self employed mortgage broker. It is my experience, stability and integrity that makes me a good loan officer. A consumer should choose carefully who they want to use based on a series of questions and how the loan officer handles that conversation. Think of the initial conversation with a potential loan officer as a first date. If it does not go well, why go out on a second date? There are a lot of fish in the sea!
Paying Off a Mortgage Early
Frugal Dad: We frugal people like the idea of living without a mortgage. What are your thoughts on paying off a mortgage early?
Dale: Frugal living in my book, means living within, or below your means. It means not buying that 56-inch flat panel and paying it off over time, not driving the expensive car because they offered you 0% interest rate on a 60 month loan and not going out to dinner every night of the week. Frugal living means thinking before you spend money on something you need or already have, being able to save every month and having a reserve fund on hand in case you lose your job or have an unforeseen expense.
Living mortgage free is more of a luxury for those frugal followers. Since most people cannot buy a home without a mortgage and there is a tax benefit for writing off the mortgage interest, it is not such a bad thing. In other words don’t feel that you need to buy a home for cash, pay off your mortgage as quickly as your credit card or keep renting if you cannot afford to buy a home.
Assuming one can afford the mortgage payments, I love to suggest accelerating them. One extra mortgage payment per year knocks a 30 year mortgage down to approximately 24 years and a few months. One extra payment can be made as adding 1/12 of the monthly payment to each month, paying one total extra payment to the lender each year or making a ½ payment every two weeks. Anyway you do it, it adds up to a total of 13 payments a year. The saving in interest is approximately 1/3 of the total interest for the life of the loan. Knocking off this much interest equates to lowering your effective interest rate by almost 2%! This is a huge savings for the borrower and paying it off early is a gigantic satisfaction.
Any way you want to look at it; homeownership is a luxury and is not meant for all. The American Dream is a dream not an entitlement. A home is typically the largest single asset one owns and should fit nicely into the entire financial picture. Remember the whole is only a sum of the parts and this part should not be too big as to swallow up everything else. With times the way they are today, the consumer should be much more vigilant, diligent and responsible in their homeownership and mortgage selection. Moving forward, there were lessons to be learned by all and hopefully we will not forget what happened in the past when making future decisions.
End of interview.
I’d like to thank Dale for taking the time to answer my mortgage questions, and I wish her much success with her book. In fact, she was nice enough to send me a copy of her book, which I’ll be reviewing here at Frugal Dad in the next couple weeks.
More About Dale
Dale Robyn Siegel is a licensed attorney in New York and owner of Circle Mortgage Group, a boutique mortgage broker in White Plains, New York. She is an adjunct professor at Baruch College as well as NYU Schack Institute of Real Estate.
Dale has been speaking to the public and teaching real estate professionals about mortgage finance for the past ten years. You can learn more about The New Rules for Mortgages at TheNewRulesforMortgages.com, and you can purchase a copy at Amazon.com or visit her virtual book tour.