Flamethrowers and certain mortgages: handle with care!
Elon Musk’s new flamethrowers, created and sold by his Boring Company, have blown up. For now, that’s just figuratively, but that could also be literally if (when) someone does something stupid and torches their house.
In the right hands, a flamethrower is probably fun, even perhaps useful. But in the wrong ones, it could be incredibly destructive. You could say the same thing about certain mortgage products.Verify your new rate (Nov 15th, 2018)
“Qualified mortgages” and “non-qualified” mortgages
A few years ago, the US government reformed the mortgage industry to outlaw the riskiest loans. The remaining products were divided into so-called “qualified mortgages” (QM) and “non-qualified mortgages” (non-QM).
Non-qualified mortgages shift more risk to the lender and away from investors and taxpayers. These products include mortgages that use your bank statements instead of tax returns to verify your employment, loans that allow credit scores as low as 500, and private (hard money) loans with rates in double digits and costing several points up-front.
Interestingly, non-QM loans may not be that unsafe, because it’s now the lender that usually eats the cost of foreclosure, not taxpayers and investors.
QMs are not exactly bombproof
However, just because you qualify for a QM mortgages doesn’t automatically make you safe — especially if you choose the highest loan amount for which you qualify. Here are a few things to consider before borrowing:
- QM loans allow debt-to-income ratios as high as 50 percent for those with great credit and other compensating factors. That means half of your gross monthly income can be going for your housing, car payments, student loans, credit cards, etc. And you still have to eat, pay for medical costs and send in that check to the IRS every year (or withhold every paycheck). There is a huge difference between someone who earns $10,000 a month and has $5,000 a month leftover for those costs and someone who earns $2,000 a month and has just $1,000 left to cover everything. There is no safety net.
- QM underwriting fails to consider expenses you have that don’t appear on your credit report. You might be paying for daycare for several kids — lenders don’t get to ask about that. You might have no medical insurance and be one hospitalization away from bankruptcy. Your commute from your new home may be a lot more expensive than your old one. That is not on your mortgage application.
- Just because you get a “safe” mortgage doesn’t insulate you from the inevitable monkey wrenches the world throws into your life — job losses, divorce, your kids moving back home…
It’s up to you to understand that your finances are more important to you than they are to anyone else, and it’s your responsibility to take care of them.
How to buy or refinance without going up in flames
Fortunately, it’s not that hard to protect yourself. Understand that you don’t have to get the biggest loan your lender approves. When you go for mortgage pre-approval, consider what amount will allow you to sleep at night and not have you going paycheck to paycheck.
- Look at what you’re paying now, whether renting or owning. If you plan to spend more than that each month on the next home (including costs like property taxes and homeowners insurance), figure out where the extra will come from. If the new home you want would cost $300 a month more, for instance, maybe you want to pay off the credit card with the $300 payment first.
- Have an emergency fund. Life happens, so before buying a home, save enough to cover at least two months of bills (if you’re a wage earner) or six months of bills (if you’re self-employed or rely on commission income).
- Make sure you have decent medical insurance coverage.
- If your marriage is on shaky ground, don’t think a new home will fix that. Divorce is a major cause of bankruptcy.
- Consider your “invisible” costs. The commute to the office. Expensive hobbies that you don’t plan to give up. The desire for a new addition to the family.
Finally, minimize the cost of your new mortgage by shopping carefully. Interest rates can differ by .25 to .5 percent between lenders on any given day. And make sure your loan matches your intentions — if you expect to move in four or five years, a 5/1 ARM, fixed for five years, might give you a much lower rate and payment than a 30-year loan. A conforming 97 percent loan may cost much less than an FHA mortgage.
And by the way, they provide free fire extinguishers with those flamethrowers.Verify your new rate (Nov 15th, 2018)