"I Ran the Credit on You and Your Fiancee. Call Me to Discuss."

That was the response I received last week from our loan officer (or loan originator, as his website says). Around July, I started kicking the idea of purchasing a home around in my head. I spoke to my sister and her husband (they own their home) and asked for recommendations and tips about the process. They told me that I should get pre-qualified for a loan to see what I can afford.

I went to my bank's website and filled out the application and waited for a response. About four hours later, I received an email stating that I was qualified for a $200,000 mortgage. Now, from my understanding, a pre-qualification means that based of the information you've provided, you can borrow X amount of dollars. Pre-approval, on the other hand, means after an application fee and the submitting various documents you will be approved for a loan from the institution (provided the appraisal matches the offer). Read more about the difference on investopedia.

My brother-in-law and sister used a realtor named Bob for the purchase and sale of their first condo. They also used him when they purchased their current home. I spoke to him and laid out our strategy for home buying, which I will lay out in another post for you guys. I told him about my pre-qual and he suggested that I should get pre-qualified again with my fiancee to see what we can afford together. He recommended Allen Smith from GuarnteedRate. Allen has been super helpful through the entire process and we will most likely use him and GuarnteedRate as our lender. My fiancee and I submitted the application through his website.

Now, an important component of the home buying process and a successful relationship is communication! We have been open and honest with each other since day one. She explained to me, on our second date (I think), that she ran into a few credit issues because of an unsavory ex who "handled" her finances. She had a few collections on unpaid credit cards, but she had been paying them off and actually finished earlier last year.

It was because of this communication and honesty, that Allen's email was not a shock or a point of discontent. Additionally, my credit score is strong enough to carry us both if necessary. The credit score revealed that my fiancee's credit was not optimal and would only hinder our approval. Allen went through and explained that some of the collectors did not re-report after she paid off her collections. The report also revealed a joint credit card with a high balance. His recommendation was to contact the collectors and have them re-report, or else my fiancee would be on a "credit treadmill" that will not let her credit score "move forward."

As for my credit, Allen explained that my income, savings, and investments qualify me for a $250,000 mortgage. He was prudent to say that the $250,000 approval does not mean I can purchase a home that is valued at $250,000. Rather,  several factors, known as housing expenses, are rolled into that $250K amount and cannot exceed 43% of my monthly income. This is a change coming from government regulation and the number is to help distinguish "Quality Mortgages" so lenders can avoid a second sub-prime lending fiasco. Read more about it here.

After subtracting things like credit card payments, car payments, and student loans, the loan officer will give a number that your monthly mortgage cannot exceed. My monthly mortgage, as of now, cannot be more than $1,678. This number must include PMI, homeowners insurance, property tax, mortgage interest, and the principal. Property tax can be a deal breaker on many homes because a higher the property tax means you will only be able to afford a "cheaper" home. Let's break it down in two scenarios...

Home 1
Price of Home: $200,000  
Down Payment: $10,000 (5%)
Taxes: $2,500

Here is what you would pay per month....

PMI: $80
Home Insurance: $100 (just an estimate, this can be lower after discounts)
Property Taxes: $208
Mortgage Interest: $400
Principal: $527
Total: $1,331 (monthly mortgage)

Home 2
Price of Home: $200,000  
Down Payment: $10,000 (5%)
Taxes: $6,000

PMI: $85
Home Insurance: $100
Property Taxes: $500
Mortgage Interest: $416 (this goes up because of the money you are escrowing for property tax)
Principal: $527
Total: $1,628 (monthly mortgage)

Disclaimer: this is the first time I am making these calculations. My math might be off a bit. Check out bankrate's mortgage calculator to see what your mortgage could look like, please note that their calculation does not include homeowners insurance.

Based on this, someone with my housing expense limit would just barely qualify for the mortgage on the second home and definitely qualify for the first one (an alternative option would be to make an attempt at an 80-10-10 mortgage or increase their down payment). At the end of the day, finding the right home may come down to a balancing act between the factors that determine what you're able to pay monthly.

Next Monday, I'll post about budget management and savings. Stay tuned and feel free to comment or ask questions.