Answering That Six-Word Question
Maybe it’s me, or maybe not. Normally it happens at a party or other social event. When someone finds out what I do there’s a question that is invariably asked. It seems inevitable.
Ask yourself, what pops into your head when that nice person you are talking with identifies themselves as a mortgage broker? I’ll bet it is some variation of, “What are interest rates doing today?” Which usually means, what is the interest rate that you could get today?
Well, I have wrestled with what the appropriate answer should be for the last 20 years. I want to be accurate, but not trigger the listener’s eyes to cloud over and roll back into their head.
Interest rates are personal, like someone’s blood pressure or cholesterol count. There is a broad range of possible readings. To discover where on the spectrum an individual belongs calls for specific information. At a party this is where I can lose someone … if you are still reading and are curious as to the factors which influence your mortgage score, then here goes.
Mortgage Interest rates are a measure of risk, the danger that the lender’s money will be not be paid back. A lender is concerned with three basic elements of risk:
• The borrower’s ability to repay;
• The borrower’s willingness to repay;
• And the likelihood that the property used to secure the loan can be converted quickly back into cash.
Each of us has a risk profile, which is a measurement of these factors.
Our ability to repay is a straightforward calculation of our debts as a percentage of our income. It is the only factor where you are either in or out. By qualifying for this ratio, you’ve earned the same rate as Bill Gates. In today’s market the total of all our monthly payments (including our mortgage) cannot exceed 43 percent of our gross monthly income.
Other factors involve the stability of our income. For instance, a self-employed borrower’s income is viewed as less stable than a wage earner’s salary. A wage earner’s pay is generally speaking a steady and reliable one. A self-employed borrower needs to prove over time that they can be dependably profitable. Lenders traditionally look for a successful two-year history of tax returns showing stable or rising income. Job gaps of longer than a couple of months over the previous two years are an additional issue that can affect eligibility.
Our willingness to repay our debts is measured by our credit scores. Here, lower credit scores usually mean higher rates. Technically these scores also evaluate our ability to manage debt, but they also will include late payments, collections, repossessions, bankruptcies and other possible evidences of a refusal to honor our commitments. Over time mistakes and misfortune will be offset by good credit practices. Negative credit will usually drop off in seven years and cease to be much of an influence after three or four years.
Collateral is the third consideration in risk assessment. Like credit, variations will result in different interest rates. In the event of a default a lender wants to be able to convert the property into enough cash to replace their original loan amount and any interest owed. They also evaluate the likelihood that the collateral will be abandoned when payments become too burdensome on the borrower.
An illustration would be a primary home versus an investment property. What happens when times get tough and a borrower has to choose which payment to make? It is more likely that payments will be stopped on a property where the borrower doesn’t live than to risk being turned out of one’s home. So loans for investment properties carry a higher interest rate.
Another example involves equity. A person with a 50 percent equity position is less likely to walk away from a mortgage then one who has no investment. That’s why purchase loans with less than a 20 percent down payment will require an additional mortgage insurance payment and a higher rate.
Well it only took me 669 words to answer that six-word question. If you are still with me then I will leave you with this nugget from H.L. Mencken:
“For every complex problem there is an answer that is clear, simple and wrong.”
Neil Funsch has been a mortgage broker for 18 years, the last four in Park Hill. He can be reached at 303-229-2684 or neil.funsch@gmail.com.