Mortgage Definitions

Front End & Back End Debt To Income Explained

What Is Front End DTI - Back End DTI

Many people meet the Debt to Income (DTI) ratio when they fill documentation for qualifying for a mortgage. The mortgage broker will show some of the lenders limitation and will request them to calculate ‘Back End’ Debt to Income and ‘Front End’ Debt To Income.

In this short review we will explain and give easy examples for these two mortgage definitions, so the process of getting a mortgage or refinancing your mortgage will be more understandable.

Debt To Income Ratio

This DTI ratio is a figure that tell the lender how much money you will owe from your overall gross income. Lenders will want to see how much from the monthly income goes on the mortgage payments (Front-End) and also how much from the monthly income is spend on ALL debts (Back-End) mortgage payments and other fixed payments and expenses.

When people owe too much money from their monthly income, it means they are a risky customers for the lending banks. If the lender determines the Debt to Income limit to 40% and when checking the mortgage request the DTI (Debt to Income) ratio is 50% from their income, it means that:

• They plan to buy a home which the can not afford.
• The mortgage length is to short, and needs to be extended.
• The borrower may be turned down for this request.

Front End Debt To Income Calculation

The calculation for the Front End debt to income is quite easy, DTI ratio needs only two parameters, Income and Mortgage Debts. There are many online calculators you can use, after you understand the principle of the Debt to Income ratio. 

• Income - The best way to calculate the Income factor is to find the annual income based on your last two tax returns, and divide it by 12. It is better to be done like this, as monthly income can vary for self employed unlike salary workers. In the annual income for the DTI is you need the gross income – before taxes.
• Debts - The Front End’ Debt To Income, measures only the home mortgage expenses, so you need to sum the mortgage payment and add the private mortgage insurance, homeowner’s insurance and property taxes too.

When you divide the Debts by the Income, you get the DTI ratio.

Front End Debt To Income Ratio Example

If a family annual income is $120,000, and divided by 12, the monthly income is $10,000. The family requested a mortgage for 15 years which the monthly payments where calculated to $3200 per month. This includes the mortgage and the insurance and the property taxes. Their Front End debt to income ratio is 32% (3,200 divided by 10,000).

Back End Debt To Income Calculation

This is the more relevant figure as this figure calculates the real debts of the family. Finding the back-end DTI is simple just like the front-end DTI, except that here all the debts are calculated not only the house financing. here is how the Back-End Debt to Income is calculated:

• Income - Find the annual gross income before taxes (based on your last two tax returns) and divide it by 12.
• Debts - Here you need to sum up the house financing debts (mortgage and insurance just like the front end calculation we just did). On top of the mortgage monthly payments ALL the other debts needs to added: Monthly car loan payments, student payments, credit card fixed expenses.

Back End Debt-To-Income Ratio Example

With the same income of $10,000 per month, the Back-End DTI now will be different, as the family has two car loan payments, a student loan and other credit fixed expenses, all their debts sum to $49oo. Now their Back-end debts to income ratio is 49%. This means that nearly 50% of their income is turned to debt payments.

Qualifying Rate for Debt-to-Income Ratio

Since most lenders require a limit of 45% this family will be denied the mortgage they requested, the payments will be to heavy on the family’s budget and it can be predicted they are a risk for the lender.

The family in this example can either:

• Search for a cheaper home, as they cannot afford the home they requested the mortgage for.
• Buy the same home but request a smaller mortgage loan, more cash on hands, so the front-end debt to income will be lower and the back-end will decease too.
• Or they can extend the 15 years mortgage to a 25 years mortgage, (without changing the mortgage amount) and the monthly payments will decrease to $2200 (front end) and their new back-end debt to income will be 39%.

In cases where the debts are shifting as a result of long term loans like interest only loans where in the first years they borrower pays only the interest and later the principle loan, the lenders will calculate the Back and Front Debt-To-Income by the higher figure and not the current low monthly payments.

This helps them (and the borrower) be secured from unpleasant surprises where the debt which needs to be paid inflates dramatically in the coming years.

Mortgage Closing Fees & Costs Explained

Mortgage Closing Costs

When taking a mortgage and calculating whether you have enough money to buy the house, there are other closing mortgage costs that you must know of before. 

Except the sales price of the home, there are a many other costs needed to be paid prior to the completing the mortgage deal.

What are mortgage closing costs

There are many mortgage closing cost, which can change from a person to person, and from one mortgage to another. Here are the main loan closing costs associated with the mortgage loan.

You should know most of them are worth negotiating terms to lower the costs.. the money you will have to pay will be needed as cash on hand payments before the mortgage is even given.

You should shop carefully and examine all the fees and terms prior to closing. It is generally too late to change those fees and terms at closing.

1. The Real Estate Agent fees – It is common that the buyer pays for if he used a real estate agents to find the property he buys. The amount usually stated as a percentage of the price of property, and can be negotiated before the agent gets to work.

2. Loan Origination Fee -The money is paid to the loan officer who handled the mortgage deal and worked through the whole documentation process. The amount is usually a flat dollar amount.

This “application” fee and an “underwriting” fee either to take the place of or be in addition to a mortgage origination fee.

3. Loan Discount Points or Mortgage Points -  This is a one-time charge by the mortgage lender in order to give you a lower interest rate on your loan.  The idea is that when you pay 1% of the loan upfront, you lower the risk or the lender which makes it worth giving you the mortgage interest discount.

Its a simple calculation to find out whether it is better paying the mortgage point upfront or stay with the current interest rate on your loan. 

4. Appraisal Fees- Because the lender has to get money valuation estimate for the property you wish the mortage for. The bank will  ask  independent, certified, licensed appraiser to visit the property and make an evaluation. The appraisal fee covers the cost for this visit, and are negotiable since it’s an independent appraiser who will be coming.

5. Credit Report Fees- Those are payed in advance while getting your credit score from the bank. The lenders companies will require a credit report to determine how risky it would be to give you the mortgage. It is this credit score that will influence the mortgage interest rate, and the terms of the mortgage loan you will get. This score is some estimation on your financial ability and willingness to repay the loan. The higher your credit score, the better chances for you to get a good loan.

6. Mortgage Insurance Application Fee – While asking for the mortgage, you will need in some cases to get an insurance application fees. Those fees are part of the money on hand you need to keep as part of the closing costs for the loan.

Check here for more mortgage definitions.

Mortgage Points

Mortgage Points

A mortgage point equals one percent of the total mortgage amount. To make it simple it’s a single % point of the amount you’re trying to borrow. If you ask the bank for 150,000 dollars, then 1% of this sum is $1500. This is one mortgage point value for you on this specific loan.

When to use mortgage points

If you get the mortgage interest rate from the lender and find out that the monthly payments are higher than you think you can handle, then you can offer the bank or lender to pay one mortgage point up front. If they agree, the $1500 will be payed with the other mortgage costs (loan origination fees, insurance fees) at the beginning, and the mortgage interest rate will be slightly lower.

This is a simple refinancing trick to lower the interest rates on your new mortgage. It is important that you check with a mortgage broker, that paying these mortgage points up front will actually save you money.

It makes sense to use mortgage points (or mortgage discount points) when financially it is worth it, and whether you have the cash on hand to pay it upfront. You as a smart buyer should do the calculation when paying mortgage points saves you more money than the alternative of paying a higher interest rate.

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Loan Origination Rate Explained

Loan Origination Rate

When you decide that you need a mortgage for buying a new house, you should do a research to get loan and interest quotes. You are the buyer of the loan and part of your financial responsibility is to shop for the best offer you can find.

Some may under estimate this stage in the mortgage or home loan refinance process. But every little bit you can save, that may seem too ‘small’ to argue about can sum up for a lot of money! If you manage by mortgage rate quote shopping to save $30 every month, it gathers to an impressive sum of $10,800 savings for a 30 year mortgage! So shopping is highly recommended.

Getting Pre-Qualification

The first step will be a process of pre-qualification with the loan officer who helps you through these first steps.

It is very common that the bank or lending company will ask the loan originator to supply certain credit, asset, employment, FICO score and housing information to a specified bank or lender to initiate the underwriting of the loan application.

In this process there is a need for documentation gathering, some research to be done, and th loan broker who handles this process will be managing it all. For this service and counseling the origination rate is set.

Loan originators are loan officers, mortgage brokers, or simply sales people. Loan origination fees is payed to the loan officers who do this process. A loan origination rate is a negotiable payment outside the mortgage loan payments. This originating loan fees, you will be asked to pay in cash at mortgage closing.

If you have enough cash on hands, it might be financial wiser for you to pay mortgage origination rate  and not have them mounted on your mortgage, higher mortgage will carry interest rate for the whole mortgage life term, so paying outside closing (POC) can be a way to save money on a lower mortgage interest rate.

These mortgage points are paid to the loan officer who completes the loan transaction with the homeowner. Because these are part of your expected loan closing fees, you are in a great position for negotiation with the loan officer for a better interest rate.. or you walk from the deal…

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Property Tax Rate Explained

Property Tax Rate

It is worth to know your property tax fees in advance since they are part of the money you will need to consider like other mortgage loan closing fees. Planning ahead and knowing your limits is important when coming to complete a mortgage or refinance process.

You should check property tax rates by zip code or by state as they vary from place to place, and you do not want to miss the tax payments, as this will be reported to your FICO report, and if the tax payments are not paid on time, this can end up with a tax lien trouble, which will lower your credit score.

A tax rate is the amount of tax on each $100 of the assessed value of the property. The rates may change from year to year.

How are the property taxes fees calculated

There are 3 types of classes, but only the first class is influencing your money.

Class 1, which means your property tax rate is $0.85 This is the tax rate for most residential real property, including multifamily.

The amount of tax due is determined by dividing the assessed value of the property by $100, then multiplying that amount by the rate for the class associated with the property. If the price of your house is $200,000 then the sum is divided by 100, which makes it 2,000 and this is multiplied be $0.85.

You will have to pay an annual property tax rate of $1700.

Check here for more mortgage definitions.