Beware The Mortgage Calculator

This pops up every now and again so I'll address it once more. Mortgage calculators are ubiquitous and may keep you from buying the home you love. Here's how this happens:

Internet-based mortgage calculators take two main factors into consideration when determining "how much house can you afford".

1. Income
2. Debt

The calculator also may ask for assets/downpayment information, but the two items above are the main factors.

Next, the calculator multiplies your income by a factor of .33 to .38 to calculate debt ratios and, voila -- there is your answer. You can afford x amount of a home. The problem is, the formula ignores the most major component of a mortgage approval -- your credit.

The mortgage calculator does not consider any of the following important factors:

• Recent bankruptcies
• Collection items
• FICO score
• Outstanding judgments or liens
• Intended use of property (i.e. investment property)
• Type of property (i.e. non-warrantable condominium, 6-unit)
• Other risk factors

Some users will say, "I am buying a plain vanilla SFR home with a plain vanilla mortgage. I am putting 20% and I have terrific credit -- the calculators are great."

To that I say, "wrong again."

My favorite component of mortgage approvals is I call compensating factors. The name explains exactly what it is: if the borrower is less-than-outstanding in one of the standard mortgage criteria -- income, equity, credit -- the loan may still be approved if the borrower is an over-achiever in another of the criteria.

This is powerful stuff and the mortgage calculators miss it.

For example, if a family earns a modest salary and is purchasing a home that is at the upper-end of their range, you may see a debt-to-income ratio of 47% or even higher. The mortgage calculator would look at this scenario as too risky and would tell the homebuyers that the home is too expensive for them.

However, the family has a strong compensating factor. Their middle credit scores are 788 and 802. In reality, the loan would be approved even though the calculator said otherwise.

This is not groundbreaking stuff, but one that gets missed by nearly everybody to whom I speak. Even Fannie Mae, the quasi-government organization that purchases mortgages has calculators on their site.

If a family uses mortgage calculators to determine how much home they can afford and the calculators are inaccurate, it stands to reason that plenty of Americans are not buying homes because they don't have an accurate representation of what they can truly afford.

The logic continues. Most homebuyers are in the wrong mortgage for their financial plan and goals. Yet, mortgage calculators allows homebuyers to choose a mortgage product and interest rate for purposes of calculating a monthly obligation for a home.

So, if a homebuyer selects a 30-Year Fixed mortgage at 5.50% instead of the more appropriate 3-Year Interest Only ARM at 4.125%, the homebuyer is inadvertently adding hundreds of dollars to the monthly obligation.

Again, the mortgage calculator is misleading the homebuyer.

As more and more people turn to the Internet as a home search starting point, the problem is likely to exacerbate. That is why I always recommend that real estate agents check, and then double-check, that their clients have a professional Mortgage Banker working for them. Only a licensed professional can tell a homebuyer exactly how much home can be afforded.

Homebuyers undoubtedly find they can afford 10-25% more home than the mortgage calculator could predict. Compensating factors or not, there is not substitute for a professional mortgage evaluation.