Payment Shock


Gustan Cho Associates

A home buyer should not only consider whether or not they qualify for a mortgage loan but also consider from what they are paying for rent and what their payment will be and consider whether or not they will be able to comfortably afford the new housing payment versus the current housing payment.  Mortgage lenders will definitely take a look on what the mortgage borrower’s current housing payment is and see what the proposed new mortgage payment will be and evaluate whether or not the new home buyer will be able to afford the new housing payment.  The new housing payment that mortgage lenders will analyze will be the principal, interest, taxes, and insurance.  If the new home purchase of the home buyer has homeowners association dues, that will also be part of the new proposed housing payment.

Payment shock is a mortgage industry terminology that is used for what happens when a home owners monthly housing payments goes up.  Monthly housing payments can increase due to an adjustable rate mortgage loan after the intial 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.  Home buyers who are living rent free with family will definitely have their monthly budget increased due to the responsibility of having a monthly housing payment from living rent free.

How Do Mortgage Lenders Calculate Payment Shock?

Mortgage lenders calculate payment shock by dividing the new proposed housing payment by the old monthly housing payment.  If the new payment of a new home buyer is $1,700 per month and the old rent payment was $1,100 per month, mortgage lenders will calculate dividing the old payment of $1,100 by the new principal, interest, taxes, and insurance housing payment of $1,700 which yields a payment shock of 155%.

Payment Shock And Mortgage Qualification

Mortgage lenders take payment shock seriously, especially for mortgage loan borrowers who have marginal credit and higher debt to income ratios.  Mortgage loan borrowers normally like to see payment shock of no greater than 125%.  In cases of higher payment shock, mortgage lenders want to see compensating factors.  Compensating factors are positive factors a mortgage loan borrower can provide such as reserves, savings, investment accounts, income that is not used to qualify for income, IRA accounts, 401k accounts, or other assets.  The purpose assets are viewed as compensating factors is in the event if the mortgage loan borrower 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

Home buyers 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 you for a mortgage loan and your 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 you.  Remember that homeowners have added expenses than renters.  Chances are that your utility payments will be much higher if you go 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 if you are renting an apartment or home but you need to pay those yourself if you are a homeowner.  Plus you need to always have reserves if you are a homeowner because in the event your appliances break down or your furnace or air conditioning unit malfunctions, you may need to replace those.  Some repairs can cost you hundreds of dollars if not thousands.

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The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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