DTI, LTV, PMI - having trouble keeping up? Let’s break it down for you.
Getting started down the path to homeownership can be intimidating, and unfortunately, that first phone call can leave you more confused than before you made it. Let’s get you prepared to have a great lending conversation.
Is this a joke?
Getting started on the path to homeownership can be intimidating. 90% of the time, there will be a loan involved in the purchase, and unfortunately, that first phone call can often leave you more confused than before you made it.
The real estate industry very well may take the cake for obnoxious acronyms. After all, in 2015 the CFPB advocated for a reform to the HUD-1 statement with a law called TRID, which itself combines two acronyms (TILA & RESPA). If that’s not dizzying enough, let’s get started on some of the terms you’re likely to hear when you start the mortgage loan application process.
How much can you afford?
We will begin where most loan officers begin and the question you most want answered: how much can you afford?
This is a function of your debt-to-income ratio, which you’ll hear referred to as your DTI.
The loan officer will take a look at your gross income, determine how much is owed to other creditors (by pulling your credit report), and work backwards from a monthly payment to figure a maximum purchase price. The DTI ratio for which a lender will approve you depends on your credit worthiness (or credit score) and loan type, and it ranges from 40-50%.
Want to be approved for a higher sales price? Your options are to improve your credit score, pay off some of your current debts, or put down a larger amount on the home, which would reduce the LTV.
The acronym LTV stands for loan-to-value ratio.
This answers how much of the sales price is going to be covered by the mortgage. If you were to put down 20%, then you would have an 80% LTV. Obviously, the larger amount you put down, the lower your DTI will be because you are financing less money.
Down Payment Assistance
For many people, especially first-time homebuyers, the problem is a lack of capital available for a down payment, and that’s where DPA - down payment assistance - comes to the rescue.
As you’re investigating your financing options, I encourage you to ask your loan officer about the availability of DPA programs in your area. Some of the more popular ones in our area are CHFA (which you may hear as “chaffa”) and metroDPA.
The government recognizes the benefits of homeownership, as well as the sometimes overwhelming point of entry, and therefore has created these programs in order to make it possible for individuals without a lot of capital to realize one aspect of the American dream.
These DPA programs are not exactly free money. There may be income guidelines, property location restrictions, as well as repayment timelines. Whether you choose to pursue one of the programs will depend in large part on your plans for the purchase.
Loan Types and Mortgage Insurance
The type of loan you choose will also be determined in part by your plans for the purchase. The three most common loan types are conventional, VA, and FHA.
VA is an acronym for Veterans Administration. Veterans who meet certain criteria are eligible for a VA Loan, which is a 100% LTV product. Regardless of your ability to qualify for a VA Loan, we thank you for your service.
As someone who is now familiar with loan acronyms, you’re able to see that the VA Loan is a well-deserved benefit to our veterans that allows them to make a home purchase with zero money down.
If you’re a first-time homebuyer, you’ll likely be offered an FHA Loan.
The Federal Housing Administration (FHA) will insure a loan issued with certain criteria. Since the risk to the lender is lessened by the FHA insurance, the FHA Loan has a lower point of entry in a few ways.
To start, the FHA Loan can be offered with just a 3.5% down payment, or at 96.5% LTV. It also carries with it a minimum credit score of just 580. Now, if your credit score is that low, the lender will be a little more strict on your DTI. Now we’re cooking with gas!
Borrowers will have to pay a mortgage insurance premium (MIP) with the FHA Loan. Doesn’t make a ton of sense that you’re the one who pays for the insurance the lender gets, but let’s move on…
The third most common loan type is not an acronym itself, but I bring up the conventional loan type to make an important distinction between two other acronyms.
It’s a common misconception that you must put down 20% in order to be approved for a conventional mortgage. In fact, they can be found sometimes as low as 3% down, which is even less money down than an FHA Loan.
However, if your LTV is greater than 80%, you will likely be forced to pay for private mortgage insurance, or PMI.
PMI and MIP are effectively the same thing. You, the borrower, pay a monthly insurance premium such that in the event of your default on the loan, the lender is made whole. Again, it’s a little frustrating to learn that you pay for their insurance policy at no benefit to you, but at the end of the day, you want the money, don’t you? Well, this is the cost. In addition to the other cost (the interest). I digress…
Choosing the right loan for you
So what might make the difference to an individual considering a conventional or an FHA Loan?
For starters, we’ve already discussed the lower credit score allowed on the FHA Loan product. If you’re a person with little capital available for a downpayment and not enough credit history to have a great score, then FHA might be the product for you. In addition, you will likely receive a lower interest rate by going FHA instead of conventional.
On the other hand, let’s say you have fantastic credit and you receive comparable interest rates on either product. A big benefit of going with the conventional loan is that eventually, you can drop the PMI premium from your monthly payment.
At 80% LTV (whether by appreciation or your paying down the loan, or a combination), you can ask the lender to drop the PMI payment, and at 78% LTV, the lender must drop the PMI premium, whereas the MIP associated with an FHA Loan must be paid for the life of the loan (that is, until you sell the house or refinance).
There are other considerations that might make the difference in the loan type you choose. For instance, a VA Loan can only be issued on a property you intend to occupy.
A good loan officer is going to consult with you on your options, discuss your goals and plans, and help you find the product that’s right for you. Now that you’ve learned what some of these fees are, as well as understood what the acronyms mean, I’m confident you’re in a better position to have a financial conversation.
Let me know when you’re ready to speak with one of my trusted financial partners.