How Are Mortgage Rates Calculated in Texas?
I get this phone question a lot. “Hi, I’m Bob, and I’m from Somewhere, Texas and I want to know what today’s mortgage rate is?”
It’s a good question. How are rates calculated and why would someone have a different rate than another person-already f they both have identical credit scores? Some people think mortgage rates are only based on credit scores but it today’s post I’d discarded some light on the other factors edges use to determine your mortgage rates.
How are mortgage rates calculated?
Short Answer: The current economic market conditions and the loans overall risk determine the mortgage rate.
If today’s mortgage rates are in the 4% range (like right after 9-11) you’re going to get a better rate than right now when rates are in the mid-6%. This is an example of how the general market conditions affect rates. I could go into how mortgage rates are priced according to the mortgage-backed bond market but that’s too technical for now
So, in a nutshell, the two major factors that determine rates are the current economic market conditions and the risk of the loan.
Notice how mortgage rates go up when we have positive economic news and down when we have negative economic news. This isn’t always true but it’s a good rule of thumb. This is why working with an experience mortgage person is so basic. If your mortgage person just gives you a rate without doing his/her homework there’s a danger in the loan not going well-especially in today’s market.
Inexperience loan officers (like bank loan officers who aren’t licensed) just give you rates-but rarely know things like “Is this a good time to lock the loan or should we wait to lock.” Would they already know what economic situations might arise that could raise or lower your rate. Usually not. An experience mortgage specialized will let you know what’s happening in the mortgage market since any sudden increase could cause your payment to go up unrepentantly. This is especially for jumbo home loans where ever .25% point might represent $100 higher payment.
How are mortgage rates calculated?
Long Answer: edges price home loans according to the overall risk of the loan and there are 5 major categories to consider.
The Basic Steps to qualifying for a home loan.
Job: How long you’ve been on the job? For example, a person who just started a job in a new career is considered higher risk than a person who’s had the same job for 25 years. Most edges want to see a 2 year employment history.
Credit score: I’ll go into this in more detail later, but most edges want to see a 620 score. Once upon a time, you could get a 100% home loan with a 570 -but those days are gone for now. Now edges want to see a 620 score or you’re putting 20% down. Why is 620 the magic number-because the PMI companies won’t insure a loan over 80% without a 620 credit score. Remember, PMI is applied to loans that go beyond 80% loan to value.
PMI: Whenever you see a market-wide change in lending it’s usually because of the PMI companies. For example, when edges lower or raise the general loan criteria, what’s really happening are the PMI companies are raising or lowering their guidelines and the edges are simply following suite. One of the little-known secrets about the mortgage market is how big a role PMI companies play. They are major driving force behind bank’s lending guidelines. Notice how Jim Cramer of Mad Money always seems to segway into PMI companies when he’s discussing the mortgage market.
Remember, when 100% loans went away for most retail edges? Now you know why-PMI companies stop insuring these loans so edges stopped offering them. And uninsured loan is a higher risk loan. And because edges only want uninsured loans for the high credit score borrower-usually an exit by the PMI company causes and exit for the edges.
By the way, as a mortgage broker, I nevertheless offer 100% home loans but in the form of an 80/20.
Debt to income ratio: This is as a biggy! This is as big of an issue as your credit score. It’s also known as “Debt Ratio” “DTI or “DR” This is the ratio of your income over your debt. For example, if someone makes 10K and they have 5K in basic debt they have a 50% debt ratio. Most edges like to see a 40-45% debt ratio.
One of my little pet peeves is when someone calls me and asks “what’s your rate-I have excellent credit scores.” “Great, but what about your Debt to income ratios” is my shared response. Because a teenager can have an 800 credit score, but can they buy a home? No. Why-because they without the income usually.
This is why most specialized mortgage people insist on getting a complete application. Mortgage people don’t ask you all these questions because we like to use money on credit reports and like taking the getting pay stubs, etc. It’s because when we issue approval letters of approvals we want to make sure the loan goes to funding without any problems
Loan to Value Or “LTV: This simply is the ratio of the value of the home to the loan amount. For example, if you’re buying a home worth $200,000 and you’re putting down 5% down your LTV is 95%–since you’re putting 5% down. In general, edges like 3-5% down. But the best rates are on 20% down.
So, in general, one’s debt to income ratio, job, PMI and Loan to Value (LTV) and credit score determine if you can truly buy or refinance a home.
Now that we have the basic 5 discussed, let’s address the overall risk of the loan and how these factors excursion the loan rate.
Employment/Income Documentation: Ever hear the phrase, “Show me the Money!!”? Well, when buying or refinancing edges want to what you make but they also care how you are paid. Are you a w2 or 1099 kind of employee? Are you self-employed or can you give me tax returns to document your income? The safest loans-at the minimum in the edges eyes– are w2 employees. Why-because these loans are fully proven loans– “complete Doc”-and these loans statistically have the lowest foreclosure statistics.
The less the bank documents one’s income the higher the risk. And remember, the higher the risk the higher the rate.
Most of the foreclosures we’re experiencing now came from the 100% loans where the bank didn’t require income documents. They simply took the client’s information for it! And now edges are paying dearly for it.
However, just because someone can’t document their income this doesn’t make them high risk. Most self-employed people can’t document all their income since they have business expenses they generally deduct.
So when I can’t document the client’s income, the bank usually will allow the loan approval-they just want this client to put 5-10% down. And, you guessed it, edges charger a higher rate when I can’t document all the clients’ income (since these loans have higher risk.)
Sometimes this income documentation rule goes too far in my opinion. I remember working with a physician who made 200K as a hospital employee but recently started his own practice where he was guaranteed 400K for the next two years. Could I do his loan? NOPE! Why-because the bank would NOT give any value to his new, 1009 self-employment income unless I could show a 2 year history.
Loan Size: Here’s the magic number. $417,000. If you’re loan is $417,000 and lower you qualify for regular mortgage rates. If your loan is over $417,000 your loan is classified as a jumbo mortgage and consequently, you guessed it, these jumbo loans come with higher rates.
Why $417K-I don’t know. My guess is someone, somewhere made this rule and their birthday was April 17 (4/17) and they wanted to feel like they made their mark on the world.
Okay…let’s pause right here and look at these two people and see how two identical twins can have drastically different mortgage rates.
Mike and Billy: Both have 800 credit scores. But person make 200K. But Mike is w2 and wants to buy a home with 20% down. His rate might be 6.25%
But Billy, always the showboat, wants to buy a $500,000 home (jumbo) and wants 100% financing. His rate might be 8% because he’s classified as a jumbo loan and he wants 100% financing-which is the highest risk loan obtainable.
So two identical twins with identical scores could get two drastically different rates because of the size of the loan and the loan to value (LTV).
Loan to Value exceeding 90%: As a general rule, edges want to see a 3-5% down payment. So when your loan exceeds 90%–or you’re putting less than 10% down the rates are higher. The less you put down the higher the risk, the higher the rate. Rate is tied to Risk.
So a 5% down loan will have a higher rate than a 10% down. consequently a 100% or 80/20 home loan will have a higher rate than the 5% down.
Lower Rate: 10% à 5% à 0 down. Higher Rate.
Debt to income: Over 45% is considered high. So if your debt ratio is 50% your rate or payment may be higher than if your debt ratio is 30%. If you’re Debt Ratio is 55%-60% you may not qualify for the loan at all unless you’re willing to put more down.
Where the home is located: Up until recently, before this recent foreclosure activity, where the home was didn’t really matter too much. However now, edges are limiting your loan’s LTV based on where the home is located. Fortunately there aren’t too many “foreclosure hot spots” in Texas but other parts of the country like Florida and Vegas are really getting hit hard. If you’re home is in a declining area most edges will limit your loan to 5% less than normal. So if you qualify for 10% down typically, the bank would reduce your loan amount to 85% and you’d have to come in with 15% plus closing costs.
kind of home: Single Family homes have lower rates than duplexes.
Credit scores: In general the normal credit thresholds are: 620, 660, 680, 700, and 720. For some mortgage programs one simply needs a 700-720– like with 100% financing. Other programs you’ll need a 660. How these credit bands affect your rate is edges have charge higher rates for credit score less than 680. So you may qualify for a 3% down home loan, but you’re rate may be higher because you only have a 640 credit score.
Escrows: edges prefer you pre pay your taxes and insurance to them so they never have to worry if the taxes and insurance are being paid. Naturally, if you pay your own taxes you opening the bank up to a possible tax lien and consequently they charge higher rates if you want to “waive escrow” or pay your own taxes and insurance. Usually this “rate hit” is .25%.