Payment Shock On Home Purchase By First Time Home Buyers
This Article Is About Payment Shock On Home Purchase By First Time Home Buyers
Payment shock is the increase of the new housing payment by homeowners versus the rent they used to pay as a renter.
- Low Payment shock is a compensating factor
- The lender wants to know that the new homeowner does not have a large increase on a new mortgage versus what they used to pay as a renter
- If a renter is living rent-free with family and all of a sudden has a new housing payment of $3,000 per month, this is a large payment shock
- However, if a renter is paying $2,800 per month and the new housing payment is $2,900, this is a low payment shock
In this article, we will cover and discuss the importance of payment shock for homeowners.
How Much Can I Afford Versus Qualify
A home buyer should not only consider whether or not they qualify for a mortgage loan.
- They should also consider what they are paying for rent
- Compare that the rental payment with their new proposed housing payment
- They should take into consideration that as a homeowner, they will have expenses that they did not have as a renter
- First Time Home Buyers should consider whether or not they will be able to comfortably afford the new housing payment versus previous rental payment
The difference between what they are paying now as a renter and the new proposed housing payment is referred to as payment shock.
How Underwriters View Payment Shock
Mortgage Underwriters feel safe when borrowers have low payment shock.
- In many instances, payment shock is of no concern unless borrowers need to use it as a compensating factor
- Under the eyes of an underwriter, a person paying $2,000 per month rent will easily have no problem in having a new mortgage payment of $2,000 as a homeowner
- Going from $2,000 per month rent to a new housing payment of $2,000 is having zero payment shock
Any payment shock under 5% is considered a compensating factor.
Importance Of Payment Shock With Manual Underwriting On VA And FHA Loans
Verification of rent is required for manual underwriting.
- Verification of rent is only valid if the borrower can provide 12 months of canceled checks paid to their landlord
- Timely payments are required for the past 12 months. Renters can also provide 12 months of bank statements in lieu of 12 months of canceled checks
- Gustan Cho Associates will waive verification of rent if the borrower lives rent-free with family members so they can save the down payment and/or closing costs for the home purchase
Living with the family rent-free letter will be provided by the lender to be completed and signed by both the family member and the borrower.
FHA and VA Loan Programs are the two loan programs that allow manual underwriting.
Importance Of Payment Shock In Manual Underwriting
Payment Shock is viewed carefully in cases of manual underwriting.
- All manual underwriting files require verification of rent
- Verification Of Rent (VOR) is only valid if borrowers can provide rental checks for the past 12 months and/or bank statements
- All rental payments in the past 12 months need to be paid timely for the past 12 months
- Renters renting from a property management company can have the property manager complete, sign, and date a VOR Form provided by lenders in lieu of 12 months canceled checks and/or bank statements
- Underwriters will take what borrower-paid as a renter and compare the new housing payment
The difference is called a payment shock.
Current Rental Payment Versus Future Mortgage Payment Analysis By Underwriters
Mortgage lenders will definitely take a look at what the borrower’s current housing payment is:
- Mortgage Underwriters want to see what the proposed new mortgage payment will be
- Underwriters will evaluate whether or not the new home buyer will be able to afford the new housing payment by comparing what they were paying as renters
- The new housing payment lenders will analyze will be the principal, interest, taxes, and insurance and compare it to what the borrowers’ previous rental payment was
If the new home purchase of the home buyer has homeowners association dues, that will also be part of the new proposed housing payment.
Paying Rent Versus Proposed New Mortgage Payment
New homeowners should make sure they do not purchase too much house.
- Remember that lenders do not take into account certain debts not reporting on the credit report
- How much home can I afford is the key question new homeowners need to ask themselves
You do not want to buy too much home where all of your earnings go to paying your mortgage payment.
Concerns By Lenders Of The Increase Of The Housing Payments With New Home Purchase
Payment shock is a mortgage industry terminology meaning the difference between the new proposed housing payment to the previous rental payment of a borrower:
- Monthly housing payments can increase due to an adjustable-rate mortgage loan after the initial fixed-rate period
- Monthly housing payments can go up if a person is renting an apartment and is buying a large home where the monthly payments can drastically increase
- The increase in housing payment is called payment shock
- Homebuyers who are living rent-free with the family will definitely get a payment shock
They have their monthly budget increased due to the responsibility of adding a monthly housing payment from living rent-free.
How Do Mortgage Lenders Calculate Payment Shock?
Payment shock is the difference between what a renter was paying on their rent versus what a new home buyer will be paying on their new mortgage payment.
- If a renter was paying $1,000 in rent and the new proposed housing payment is $1,000, there is zero payment shock
- If the renter was paying $1,000 in rent and the new mortgage payment is $2,000, then the payment shock is 50%
- Payment shock only comes into play for marginal borrowers in a manual underwriting file. FHA and VA Loans are the only two mortgage programs that allow manual underwriting
Borrowers with over 620 credit scores with an automated underwriting system approval normally do not have to worry about payment shock.
How Is Payment Shock Calculated And Analyzed By Mortgage Underwriters
Mortgage Underwriters calculate payment shock by dividing the new proposed housing payment by the old monthly housing payment.
Here is a case scenario:
- A new payment of a new home buyer is $1,700 per month
- Old rent payment was $1,100 per month
- Lenders will calculate dividing the old payment of $1,100 by the new principal, interest, taxes, and insurance housing payment of $1,700
- Yields payment shock of 65%
Any payment shock of 5% or less is viewed as a compensating factor.
Payment Shock And Mortgage Qualification
Borrowers who get an approve/eligible per automated underwriting system (AUS) do not have to worry about the new housing payment versus rental payments.
- However, if the AUS conditions rental verification on the AUS, then borrowers will need to provide it
- Payment shock is the difference between what borrowers were paying rent versus the proposed new PITI (principal, interest, taxes, insurance)
Low housing payment is viewed as a compensating factor on manual underwrites.
Low Payment Shock Is Considered Compensating Factors By Mortgage Underwriters
Mortgage lenders take an increase in housing payments seriously. This holds true especially for borrowers with marginal credit and higher debt to income ratios.
- Lenders normally like to see the new housing payment of no greater than 5%
In cases of higher housing payment, lenders want to see compensating factors.
What Are Compensating Factors
Compensating factors are positive factors and examples are the following:
- investment accounts
- income that is not used to qualify for an income
- IRA accounts
- 401k account
- other assets
The purpose assets are viewed as compensating factors is in the event of borrowers goes through tough financial times, they have assets they can rely on in order to make their monthly mortgage payments.
Payment Shock Is Not Just For Mortgage Lenders
Homebuyers who are told they qualify for a certain mortgage loan, should take some time and think about whether the new mortgage payment is something they can afford.
- Just because a mortgage lender approves borrowers for a mortgage and monthly principal, interest, taxes, and insurance ( PITI ) payments will be a certain amount does not mean that monthly housing payment is a comfortable payment for borrowers
- Remember that homeowners have added expenses than renters
- Chances are utility payments will be much higher from renting an apartment to owning a single-family home
- Utility payments are not counted by mortgage underwriters
- Certain utilities such as water bills and scavenger services are included in monthly rent for renters
- Homeowners need to pay for water bills and scavenger services
- Homeowners need to always have reserves
- This because in the event appliances break down or furnace or air conditioning unit malfunctions, these repairs are high ticket items
- Some repairs can cost hundreds of dollars if not thousands
For more information about the content of this article or other mortgage-related topics, please contact us at Gustan Cho Associates at 262-716-8151 or text us for a faster response. Or email us at [email protected] The team at Gustan Cho Associates Mortgage Group is available 7 days a week, evenings, weekends, and holidays.