Divvy’s Mortgage Readiness Guide: Part I

If you’re a part of the Divvy program, you’ve already taken a huge first step on your exciting journey into home ownership. You’re starting to learn the ropes of what home ownership really entails, and you have a clear goal in mind; to purchase the place you call home.

So what does the leap into homeownership actually look like? What are the steps you need to take to continue your journey?

At Divvy, our mission is to offer access to home ownership, and financial mentorship comes part and parcel with this access. We understand the details of the home buying process can be exciting but also a little intimidating, and that’s why we’ve outlined a comprehensive guide to your first steps into home ownership.

This guide will be published in two parts: the first part will give an overview of what the mortgage field looks like, and the second will help guide you through the application process. Together, both will provide a holistic overview of what you can expect from start to finish when buying your home with Divvy.

How do mortgages work?

An important consideration with homeownership is understanding why mortgages themselves are so unique. A mortgage is a loan made possible by the fact that your home is serving as collateral. Mortgages are therefore different from a student or personal loan because this loan is going directly towards property with a calculable value.  This set up allows for more competitive interest rates than a credit card, for instance, meaning that homeownership is about far more than owning a home; it’s about providing access to capital.

For example: imagine you have $8000 in credit card debt.[1] This debt is fueled by cost of living, and the interest you pay on that debt, known as annual percentage rate (APR), could be at around 16% based on national credit card APR averages. [2] The national average for a 30-year fixed mortgage, on the other hand, is 4.54%.[3]  This means that qualifying for a mortgage gives you the opportunity for a loan that will help cover your cost of living at a much lower rate, taking considerable pressure off of the high debt payments you have to sustain through revolving credit.

Types of Loans

So where to begin when looking for the right mortgage? The field can be daunting, so we’ve outlined various types of mortgages to consider when applying.

FHA Loans: An FHA loan is an ideal choice if you are a first-time buyer, do not have access to much capital in hand, or are carrying more debt than you would like. This government-backed loan type was established in 1934 to boost a faltering American housing system, and it continues to serve that purpose today. These loans do come with them an extra set of premiums but are still a superior option to renting. You are also able to refinance FHA loans after your financial outlook improves. [4]

Minimum FICO score: 580 (3.5% down payment) / 500 (10% down payment) [5]

USDA Loans: USDA loans are loans backed by the United States Department of Agriculture (USDA), allowing for relatively low rates and no down payment requirement. However, these loans are not available in all parts of the country as they are specified for rural areas. Restrictions on the borrower are generally limited, but do exist: applicants must make 115% of the median income of the area, the home must be located in a specific rural target area, and the property itself must meet USDA standards. [6]

 Minimum FICO score: None set by the USDA[7]

VA Loans: VA loans are structured specifically for veterans and are optimal for former military service applicants who have small amounts of cash but solid credit. The US Department of Veteran Affairs backs these mortgages and requires the following: you have served 90 consecutive days of active service during wartime, you have served 181 days of active service during peacetime, you have served 6 years of service in the National Guard or Reserves, or you are the spouse of a service member who has died in the line of duty or as the result of a service-related disability.[8]

Minimum FICO Score: None set by the VA[9]

Conventional Loans: These loans make up the majority of our real estate system but are not backed by a government entity. They require a solid credit rating, down payment and a low debt to income ratio, and are backed by private lenders such as Fannie Mae and Freddie Mac. While requirements vary loan to loan, in 2017 the average borrower held a FICO score of 752 and a DTI of between 23% and 35%.

Many of you may be thinking those numbers don’t match the requirements given by a bank or lender, which leads us precisely to our next topic. [10]

Minimum Requirements and Overlays

When applying for any of these loans, there are two terms that can trip up new homebuyers: minimum requirements and overlays. Both vary depending on who is backing and who is issuing the loan, but these requirements can help understand what mortgage may best fit your financial circumstances.

Minimum requirements are conditions set by the institution, whether government or private, backing the loan. They act as a universal baseline for lenders to apply to criteria such as credit scores and debt to income ratios. These baselines, included in the Types of Loans section, help ensure that the housing market stays protected and that lenders do not give out loans to those unable to pay the mortgage.

Each lender may then have its own unique overlays, which are lender-specific additional requirements for loan qualification. These overlays vary because different lenders have different risk tolerances, meaning that some lenders are more comfortable with different levels of debt-to-income and FICO scores than outlined by institution minimum requirements. For instance, while the VA and USDA do not have FICO score minimums, most lenders have a 580 or 640 minimum, respectively.[11] Consider it like a second coat of paint: the minimum standards are your primer or undercoat, and the overlays are the finishing coat.[12] As such, overlays, or the requirements you may have seen at your bank or local mortgage lender, may be more rigorous and have more stringent requirements for qualifying for a loan.

What factors affect qualification?

When it comes to a mortgage, it’s not only about qualifying but also optimizing for the best rate possible. Underwriters, the individuals that evaluate your application, will consider a few factors.

The Market: Like most elements of the economy, real estate is subject to the laws of supply and demand. The more buyers seeking mortgages, the higher the interest rates lenders can seek, but the reverse is true as well. When the market slows down, lenders are forced to lower rates to help balance their supply with lower demand. Other factors you may not be aware of in the day to day, such as the bond market and regulation from the Federal Reserve Board, may also affect rates.

Your Credit: Lenders will have reservations when evaluating applicants with poor credit. They mitigate their own risk by offering lower rates to less risky borrowers, but subject borrowers with poor credit to higher interest rates. Government-backed loans allow for more credit score flexibility, but the higher the credit score, the more optionality an applicant has when applying for a loan.

The Loan’s Term: Lenders offer two types of mortgages, each of which can affect the rate of the loan. Fixed-rate mortgages offer a single rate that will stay consistent until the home is paid off or until the borrower refinances. Adjustable rate mortgages, however, carry terms that allow the lender to adjust the rate under regulated circumstances, leading to fluctuating rates for the borrower.

For some, a fixed rate mortgage is preferable as it protects against variations in payment. However, adjustable rate mortgages often have a lower bar for qualification, can offer lower initial payments, and can also enable certain borrowers to obtain a larger loan.

Why Mortgages Matter

Mortgages require an understanding of both the loan landscape and your individual financial position. By utilizing the relatively low-interest rate of a mortgage, you can benefit from the financial advantage they provide and, most importantly, transition into a place to call your home.

But even after understanding all of the facts, Divvy understands that this final hurdle can still feel intimidating. That’s why we created our own Mortgage Readiness Improvement program that includes free credit counseling and direction on how to buy your home.

Stay tuned for our next post where we will detail the step-by-step process of preparing for and finalizing the mortgage process. Owning your first home can seem daunting, but with the partner, it can be easier than you ever imagined.



[1] http://fortune.com/2018/12/10/american-household-credit-card-debt/

[2] https://www.creditkarma.com/credit-cards/i/average-apr-on-credit-card/

[3] https://www.bankrate.com/finance/mortgages/current-interest-rates.aspx

[4] http://www.homebuyinginstitute.com/mortgagetypes.php

[5] https://www.fha.com/fha_credit_requirements

[6] https://www.fha.com/fha_article?id=325

[7] https://www.usdaloans.com/articles/income-and-credit/

[8] https://mymortgageinsider.com/usda-mortgage-loan/

[9] https://www.valoans.com/eligibility/credit/

[10] https://www.fool.com/mortgages/2017/02/27/this-is-the-average-american-homebuyer-in-2017.aspx

[11] https://www.fha.com/fha_article?id=325

[12] https://www.forbes.com/sites/trulia/2016/07/29/lender-overlays-3-things-you-need-to-know/

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