Decoding Real Estate Code
Mortgage Banker, Umpqua Bank NMLS # 1424295
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Buying and selling real estate is a daunting and expensive process. Luckily, there are many experts like lenders, realtors, inspectors, appraisers, escrow agents, and friends and family to help guide you through the process. These experts use many terms and acronyms that to the first-time home buyer make no sense. I call this, real estate code.
Mortgage Lender: "Hey Charles, thanks for sending in all of your information online, I’m thrilled to help you purchase your first home. Looks like you and Becky's FICO scores are excellent and your back-end DTI is under 43%, so you absolutely qualify for this home." A mortgage lender should never talk to an inexperienced borrower(s) in real estate code, but work with me for this example because it does happen.
What in the hell is a FICO score? Or a back-end DTI? As a home buyer, all you've heard is that you absolutely qualify for this home. Awesome! Move on, right? Absolutely not. You should never be afraid to ask questions, that is why you've hired real estate professionals. Leverage their expertise. My motto is that there are no stupid questions, only stupid mistakes. This is, most likely, the biggest purchase of your life. Therefore, don't make a stupid mistake because you're too afraid to ask a simple question.
Your savior, me, is here to decode this response from the mortgage lender. A FICO score is essentially your credit score derived from three credit bureaus. Most lenders use the middle score to determine what credit score to attribute to your loan file. Credit score is a huge determinant of your approval status and what interest rate you will pay. A back-end debt-to-income ratio (DTI) is what the borrowers debt-to-income will be once they begin paying their monthly mortgage payment (front-end DTI is what your current debt-to-income is before taking on a mortgage payment, and may include your rent payment, if applicable). If it is 43%, then 43% of the borrower’s income is going towards their proposed debts.
Just because Charles and Becky's back-end DTI is under 43%, does not mean that this mortgage payment is comfortable for their budget. Although, some borrowers, if spoken to in real estate code, freeze up and only hear what they want to hear (we're qualified for this home, yay!). If Charles knew what a FICO score or a back-end DTI was, he might ask the questions: “What were our FICO scores and are they going to negatively impact our interest rate?” and "Well what is our back-end DTI? We're only comfortable if our back-end DTI is under 33% so we do not overextend ourselves.” BAM, Charles just killed the question game. The answers to these questions will give Charles and Becky a way better understanding of their credit profile and loan situation.
Hopefully this example stressed the need to understand the fundamental, often used terms in real estate. You may not understand the entire process until you've bought and sold a few houses, but at least you'll be able to follow along with the lingo being used by real estate professionals so you can ask the right questions.
Without further ado, here are some basic mortgage terms that every potential home buyer should understand:
Annual Income
This is the combined annual income for you and your co-borrower. Include all income before taxes, including base salary, commissions, bonuses, overtime, tips, rental income, investment income, alimony, child support, etc.
Down Payment
This is the amount of money you will put towards a down payment on the house. Make sure you still have cash left over after the down payment to cover unexpected repairs, financial emergencies, closing costs, and any other unexpected costs associated with buying a house.
Monthly Debt
Include all of you and your co-borrower's monthly debts, including: minimum monthly required credit card payments, car payments, student loans, alimony/child support payments, any house payments (rent or mortgage) other than the new mortgage you are seeking, rental property maintenance, and other personal loans with periodic payments.
Do NOT include: credit card balances you pay off in full each month, existing house payments (rent or mortgage) that will become obsolete as a result of the new mortgage you are seeking, or the new mortgage you are seeking.
Interest Rate
Interest rate is the percentage of the loan that you will pay in monthly payments.
Annual Percentage Rate (APR)
A standardized method of calculating the cost of a mortgage, stated as a yearly rate, which includes such items as interest, mortgage insurance and certain points or credit costs. Because it includes these other items, it is higher than the interest rate a lender will quote.
Debt-to-Income (DTI)
Your DTI is expressed as a percentage and is your total "minimum" monthly debt divided by your gross monthly income. The conventional limit for DTI is 45% of your monthly income. A DTI of 20% or below is considered excellent.
Income Taxes
This is an annual tax that governments place on individuals' income. It includes federal tax, most states and some local entities. The national average is around 30% but can vary based on income, location, etc.
Property Taxes
Property taxes are an annual tax on homeowners' property and the tax amount is based on the home's value. Property taxes are typically impounded, and paid with your monthly mortgage payment.
Homeowner’s Insurance
Commonly known as hazard insurance, most lenders require insurance to provide damage protection for your home and personal property from a variety of events, including fire, lightning, burglary, vandalism, storms, explosions, and more. All homeowner's insurance policies contain personal liability coverage, which protects against lawsuits involving injuries that occur on and off your property.
Mortgage Insurance (PMI)
Mortgage insurance is required primarily for borrowers with a down payment of less than 20% of the home's purchase price. It protects lenders against some or most of the losses that can occur when a borrower defaults on a mortgage loan. This is also known as PMI (Private Mortgage Insurance).
HOA Dues
Typically, owners of condos or townhomes are required to pay homeowners association dues (known as HOA fees), to cover common amenities or services within the property such as garbage collection, landscaping, snow removal, pool maintenance, and hazard insurance.
Loan Term
This is the length of time you choose to pay off your loan (e.g., 30 years, 20 years, 15 years, etc.)
Appraisal
An analysis of the subject property conducted by a professional appraiser who will look at a property and give an estimated value based on physical inspection and comparable houses that have been sold in recent times.
Points
Factored into the loan's APR, a point equals 1 percent of a mortgage loan. Some lenders charge "origination points" to cover expenses of making a loan. Some borrowers pay "discount points" to reduce the loan's interest rate. Often in order to get a lower interest rate, lenders will allow borrowers to "buy down" the rate by paying points.
Escrow
An account in which a neutral third party holds the documents and money in a real estate transfer until all conditions of a sale are met. Also, an account in which money for property taxes and insurance is held until paid; money is added to the account every time a mortgage payment is made.
Title Insurance
Title insurance is a policy that guarantees that an owner properly has title to a property and can legally transfer title to someone else. Should a problem arise, the title insurer pays any legal damages. A policy may protect the mortgage lender, the home buyer or both.
FICO Score
The most widely used credit scores are FICO Scores, the credit scores created by Fair Isaac Corporation using three credit bureaus to determine scores: Equifax, TransUnion and Experian. Each FICO Score is based on the information the credit bureau keeps on file about you. These scores typically differ, and most lenders will use the middle score to determine your credit score used for your loan. If there are two or more borrowers on the loan, the lowest FICO score will be used on the loan profile.
To minimize any confusion throughout the loan process, I often ask my borrowers what their level of expertise is with buying and selling real estate. Depending on their answer, I will or will not use real estate code. If they are experienced borrowers, it is perfectly okay and more efficient to talk in real estate code. If they are first-time home buyers, then one should always avoid using real estate code and instead use baby steps through the lending process.
If you have any questions or comments, feel free to contact me at (360) 937-0983 or send an email to dylanlangei@umqpuabank.com. Thanks for reading!
