By Mike Heayn Real Estate 101
IT’S IMPORTANT TO UNDERSTAND WHAT you are doing when you purchase a property, especially a home. You want to know the responsibilities homeownership entails. Of all the responsibilities that home ownership requires, paying the mortgage should be at the top of the list.
When you get a loan from a bank, they use a debt-to-income ratio or DTI to determine how much of a loan you can afford. Before the California real estate market appreciated to astronomical levels, many lenders allowed 25 to 32 percent of a person’s gross income to go toward a house payment.
Many years ago, one bank figured out that they incurred the lowest number of loan losses on home loans where 28 percent or less of a person’s income paid for the mortgage.
For example, if you made $12,000 a month a bank would allow $3,360 of your income to go toward your mortgage. If you do the math, with an interest rate of 6.50 percent you would be able to afford a fully amortizing loan of $440,000. If you put a 20 percent down payment on a property, the price would be $550,000.
These numbers are probably shocking to people who purchased homes with interest only or 100 percent financing loans due to the simple fact that qualifying for loans was much easier 18 months ago. A year and half ago many lenders used aggressive DTI ratios, sometimes allowing as much as 55 percent of a person’s income to go toward a house payment.
However, using lower DTI ratios is the way many lenders used to allow homeowners to borrow money. Many lenders, due to large loan losses and stupid lending, are paying the price for aggressive lending and reverting to the days of conservative lending with lower debt-to-income ratios.
Achieving the dream of a home is nice, but that dream quickly turns into a nightmare if you cannot make the mortgage payment.
As much as “stretching” for that home seems doable, keep in mind owning a home while being house poor, meaning you are eating canned soup every night and watching every cent you spend, is not what banks want for their borrowers.
When your loan officer explains the loan payment on your home purchase, run the numbers and see if it makes sense for yourself. Only you know what you can really cut out of your expenses.
Do not allow someone to talk you into a loan with a payment that will be difficult for you to pay each month.
I have noticed that many investors prefer interest only loans for their investment properties, and for good reason — they want a property to produce cash flow as soon as possible.
As I have stated many times before, an investor purchases an income property for the income stream.
The premium the investor pays for the income stream is determined by the market-place and the investor. However, I have also noticed that many of those same investors have free and clear homes.
Over the last month I asked many of my clients with free and clear homes or homes they live in without mortgages why they do not have loans on their homes. The majority of them gave the same obvious answer — peace of mind.
They wanted the security of knowing that no one can take their home away. Some investors refinanced income properties and used the cash out proceeds to payoff the mortgage, while others made large principal payments over time until the property’s loan was paid off. Of course, not everyone can make large principal payments, but everyone who owns a home should put some money toward the principal of the loan to pay it down.
Paying down the principal amount on your home loan helps when you sell the property and protects you from a drop in value.
For example, if you owned a home worth $500,000 with a principal loan balance of $400,000, and you paid an additional $1,000 a month, over two years the loan would be paid down an additional $24,000. If the property’s value dropped 5 percent or $25,000 and you had to sell the property due to a job loss or other circumstance, you would come close, with the sale of the property, to making enough to cover the loan balance.
You would lose the money you put into the property, which is a tough pill to swallow. However, you would not owe the bank any money or be put in a situation where you have to do a short sale, which would save your credit and allow you to purchase another home faster than just walking away from the property.
If you save enough money for a down payment and legitimately qualify for a loan, homeownership can be one of the greatest accomplishments a person can achieve. Remember that qualifying for a loan you can afford and paying down loan principal are two of the most important things a homeowner can do.
MIKE HEAYN is a Washington Mutual multi-family loan consultant. He (310) 428-1342, or e-mailed at
Originally published in the Santa Monica Daily Press print edition on July 23, 2008. Read the original PDF.