Loan Qualification Standards - Loan to Value Ratio

Many folks have no idea how qualified they are as borrowers.

There are two ratios that, together with credit score, tell how qualified you are for a loan.

The more important of these two ratios is Debt-to-Income ratio, usually abbreviated DTI. The article on that ratio is here. The less important, but still critical, ratio is Loan to Value, abbreviated LTV. This is the ratio of the loan divided by the value of the property. For properties with multiple loans, we still have LTV, usually in the context of the loan we are dealing with right now, but there is also comprehensive loan to value, or CLTV, the ratio of the total of all loans against the property divided by the value of the property.

Common breakpoints on Loan to Value ratio are 70 percent, 80 percent, 85 percent, 90 percent, 95 percent, 96.5 percent (for FHA) and 103% (for VA). Some lenders may have others. If you're between two break points, LTV always treats you as being at the next higher break point. For instance, 82% Loan to value will require you to qualify as if your loan to value was 85%.

Note that for instances where you may be borrowing more than eighty percent of the value of the home, splitting your loan into two pieces, a first and a second, is usually going to save you money, if the loans to do so are actually available. See here for an example, but government loans ( VA and FHA) are an exception to this. At this update I am unaware of any second loan program that will loan over ninety percent of the value of the property, meaning one loan with PMI may be your only option.

The maximum loan to value ratio you're going to qualify for is largely dependent upon your credit score. The higher your credit score, the lower your minimum equity requirement, which translates to lower down payment in the case of a mortgage.

Credit score, in mortgage terms, is the middle of your credit scores from the 3 major bureaus, reported upon a scoring model proprietary to a company called Fair-Issacsson. If you have an 800, a 480, and a 500, the middle score, and thence your credit score, is 500. If the third score is 780 instead of 500, your score is 780. If you only have two scores, the lenders will use the lower of the two. If you have only one score, most lenders will not accept the loan. I've never seen scores that divergent, but that doesn't mean it couldn't happen. Usually, the three scores are within twenty to thirty points, and a 100 point divergence is fairly unusual. Despite what you may have heard or seen in advertising, according to Fair Issacsson (who set the parameters) the national median credit score is 720. See my article on credit reports for details.

In order to do business with a regulated lender, you need a minimum credit score of 500. There are tricks to the trade, but if you don't have at least one credit score of 500 or higher, you're going to a hard money lender or family member.

Exactly what the limits are for a given credit score is variable, both with time and lender, even when you get into A paper. Subprime lenders (when we had true subprime) would go higher than A paper, but the rates would have also been higher. Nonetheless, there are some broad guidelines. At 500, only subprime lenders will do business with you, and they will generally only go up to about 70 percent of the value of the home. A few will go to 80 percent, but this is not a good situation to be in. Note that at this update, true subprime is basically non-existent. It isn't the lenders; it's the investors behind those lenders not being willing to loan money. The shenanigans that were worked with bond ratings mean that nobody wants to take a chance, and there are people with legitimate needs for subprime loans that neither I nor anyone else can help right now because of it. I hope the so-called ratings agencies get sued and the investors win everything.

When I first wrote this, at about 580 credit score, you could find subprime lenders willing to lend you 100 percent of the value of the home, provided you could do a full documentation loan. These days, subprime won't go over about 80% of value, period. 580 also used to be where Alt-A and A minus and government program (VA and FHA) lenders start being willing to do business with you. These days, you're more likely looking at 620 to 660 for those.

At 620, the A paper lenders start being willing, in theory, to consider your full documentation conforming loan. They won't do cash out refinances or "jumbo" loans until a minimum of 640, but they will do both purchase money and rate term refinances at 620 or higher. Below about 660, you can expect to be limited to about an 80% loan to value in the current financial environment.

At 640 is where subprime lenders used to start considering 100 percent loans for self-employed stated income borrowers. Not any more. Stated Income is essentially dead, although I'm starting to see a few portfolio lenders that will consider stated income loans. I haven't submitted any so I don't know how hostile the underwriting process is firsthand, but I would not expect it to be friendly.

660 is now where A paper will start considering conforming loans above 80% loan to value. The PMI companies are really leery of accepting credit scores below that, and there are heavy hits on the tradeoff between rate and cost below about 740, but they are obtainable. Furthermore, expect that someone whose credit is lower than 720 will probably not be able to get PMI on loans 90% or higher of the purchase price.

It is to be noted that just because you can get a loan for only so much equity, it does not follow that you should. Whereas the way the leverage equation works does tend to favor the smaller down payment, at least when prices are increasing, it can also sink your cash flow. So if the property is a stretch for you financially, it can be a smarter move to look at less expensive properties to purchase. I have seen many people recently who stretched to buy "too much house" only to lose everything because they bought right at market peak with a loan they could not keep up. Many of these not only lost every penny they invested, but also owe thousands of dollars in taxes due to debt forgiveness when the lender wrote off their loan.

Right now, there is only one commonly available purchase loan that will support 100% financing: The VA loan, which actually goes to 103% to allow the financing of some closing costs. FHA loans require a 3.5% down payment, and I can do conventional conforming purchase money loans with a 5% down payment, albeit with a PMI and a highly restrictive choice of lenders. 90% financing is very commonly available on conforming loans ($417,000 minimum, higher in certain high cost areas such as San Diego where I work). For loans above the conforming limits, sometimes I can get financing above 80% (up to 90%) .

There are other ways to buy with a smaller down payment: Seller Carrybacks and some municipal first time buyer programs to name the two most common, but both of these start a long time before you've got a purchase contract, and your agent had better be able to write and negotiate a purchase contract the right way or you're going to find yourself dead in the water. Acting within narrow time windows is typically also necessary.

There are other factors that are "deal-breakers", but so long as your debt to income ratio is within guidelines and your loan to value is within these parameters, you stand an excellent chance of getting a loan. All too often, questionable loan officers will feed supremely qualified people a line about how they shouldn't shop around because they're a tough loan and "you don't want to drive your credit score down." First off, the National Association of Mortgage Brokers successfully lobbied congress to do consumers a major favor on that score a few years back. All mortgage inquiries within a fourteen day period count as the same one inquiry. Second, the vast majority of the time it's just a line of bull to keep people from finding out how overpriced they are or to keep you from consulting people who may be able to do it on a better basis. I've talked to people with 750 plus credit scores, twenty years in their line of work, and a twenty percent down payment who had been told that, when the truth is that a monkey could probably get them a loan! By shopping around, you will save money and get more information about the current status of the market.

Caveat Emptor

Original here