Mortgage Valuations and Calculations
The mortgage industry is sometimes a very math-based business. Mortgage companies work with many different guidelines, all of which require different calculations and valuations. They evaluate the home's value and the borrower's credit, income and assets. Then they calculate loan-to-value ratios, debt-to-income ratios and down-payment percentages using these valuations. Fortunately, many of these tasks require simple and easily repeated math formulas.
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Home Valuations
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When a homeowner purchases a home, the mortgage company uses the lesser of the purchase price or the appraised value when determining the home's true value. If a homeowner refinances a property, most lenders ignore the original purchase price of the home, since it could have sold years or decades ago, and rely on the appraised value instead. Appraisers visit the home, take pictures of the home and then compare the home to other recently sold houses in the neighborhood. The appraiser makes adjustments based upon differences between the subject home and other comparable homes, and then estimates the subject home's value.
Loan-to-Value Calculation
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Mortgage companies rely on the appraised value when determining whether the home can support the amount of mortgage requested. Very few lenders want to lend 100 percent of the home's value because of the extraordinary costs to foreclose and sell a home. Most lenders require a certain amount of equity or down payment be provided by the homeowner when closing a mortgage. If an appraiser value of the home is $400,000 and the homeowner wants a loan for $300,000, the mortgage lender divides $300,000 by $400,000, which equals 75 percent. This means the loan-to-value is 75 percent, which should qualify for most mortgage loan programs.
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Income Valuation
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Homeowners provide the lenders with pay stubs, W-2s and tax returns. The lender reviews these documents and determines the amount, or value, of the borrower's gross monthly income. Most loan programs require the homeowners to prove their ability to repay the mortgage. Mortgage lenders do not want to give someone hundreds of thousands of dollars if they have no way of repaying it. Mortgage lenders compare the borrower's minimum debt payments and adds them to the new mortgage payment and compares the sum to the borrower's gross monthly income.
Debt-to-Income Calculation
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Mortgage companies use debt-to-income calculations to determine if a homeowner can afford the mortgage. Usually the mortgage company does not want the borrower spending more than 40 to 45 percent of their monthly income servicing their debt obligations. The mortgage company adds up all of the minimum payments required for the outstanding debts and the cost of the new mortgage payment and then divides the sum by the borrower's income. If the new mortgage payment is $1,800 and the borrower has a $350 car payment and two credit cards with a combined $50.00 minimum payment each month, then the borrower's total monthly debt is $2,200. If the homeowner earns $6,000 a month, then the borrower's debt-to-income ratio is 36.67 percent.
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