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Payment Shock and Why it Matters
Mortgage lenders consider many factors when qualifying someone for a home loan. We all know credit plays a large role in acquiring a home loan. However, an applicant's debt-to-income ratio, which is the amount of debt versus the totally monthly income, is also very important. Then there are other factors that many people may not be aware of such as the term Payment Shock.
Payment Shock is the difference between a person’s current housing obligation and their proposed new payment. It is especially important on FHA and USDA Home Loans. If a person is renting a residence, the lender would compare what the borrower's current rental payment is versus their proposed new mortgage payment which would include monthly amounts for your Principle and Interest, Property Taxes, Homeowner’s Insurance, monthly premium, and any maintenance or association type fees. This is very important because it is a good indicator of what someone can afford.
When a borrower is over the maximum front end housing ratio payment, shock becomes a major factor. The front end housing ratio is the total new monthly mortgage payment divided by total gross monthly income. The difference between the front and back debt ratios is the back includes the new house payment along with all other monthly debts. A person that pays no rent prior to buying a home is facing 100% payment shock. This is a common occurrence with First Time Home Buyers. This doesn’t mean someone in that scenario cannot buy a home using a FHA or USDA Loan, but it is definitely taken into consideration when making the credit decision.
Approved underwriters have to consider many things when underwriting a loan. Factors such as debt ratios, credit, and payment shock are all very important.