I was recently fortunate enough to have the opportunity to interview Dale Siegel, author of The New Rules for Mortgages. We exchanged emails in a Q&A format on the subject of mortgages, the housing market, etc. Here are her responses to my questions.

Lending Guidelines

Frugal Dad: Lenders used to operate under a 28/36 mortgage-to-income/debt-to-income ratio when calculating maximum mortgage eligibility. How has the housing bubble affected those ratios for lenders?

Dale: Lenders use ratios as guidelines for qualifying a borrower for a mortgage. It is the total housing expense divided by gross monthly income and then total housing expenses plus all monthly debt divided by gross monthly income. Depending on which lender you go to, the typical ratio that lenders work with can range from 28/36 to 33/41.

Before the implosion of the mortgage industry, many lenders would push ratios upwards of 65% of the borrower’s gross (before taxes) monthly income, using compensating factors such as good credit or low loan to value. There were also products such as no income and no ratio loans which would eliminate the calculation all together and a borrower could mortgage multiple amounts of monthly income- and are behind the eight ball now!

Ratios are a guidance tool for the lender to calculate what they think a borrower should take out. However, the true number comes from the borrower themselves.  Use the mortgage amount the lender tells you you qualify for and really analyze it based on what you know about your own finances.  Make lists of your monthly income and expenses, create a 5 year plan and see what larges expenses might be coming up in the short term and think about things in life that can mess up your plans. Only the actual borrower knows what they can comfortably afford for a housing expense without compromising too much. Remember, the lender does not take into consideration things such as food, clothing and summer camp-but you should-and you can’t have it all.

Down Payments

Frugal Dad: How much (%) should homeowners aim to put down on a mortgage to secure the most favorable terms?

Dale: Down payments should be as large as you can manage: no money or little down mortgages are history-except for the FHA. Two years ago, you could get the same interest rate with 5% as you could with 25% down. Now, the lenders use a matrix consisting of FICO score and loan to value to calculate the interest rate. So, the better your FICO score, the lower your interest rate and the more equity you have in a home the lower your interest rate.

Many lenders will not allow loans over 80% now and it is harder to get PMI (Private Mortgage Insurance) for those loans. The lenders charge higher rates for scores over 620 and for loan to values over 60%. So if your credit score is 640 and you are putting down 20% your rate will be much higher than the guy that has a 720 FICO score and is putting down 30%. This is the way all lenders work now and they all go off of the same chart. So, one bank will not be better than another in this instance. What the borrower needs to understand is how the lender calculates their interest rate and they have the right to ask for the actual computation used.

FICO Scores

Frugal Dad: To qualify for the best mortgage rates, what credit score range should home buyers aim to be in?

Dale: The credit score is more important than ever now, because the lenders go off of the pricing matrix and there are no longer compensating factors used to cover a bad credit score. The score is what it is with no deviation in pricing the mortgage interest rate. As said, the lenders would do a loan with a FICO score of 500 if the borrower had other things going for them such as low loan to value, little debt or a lot of assets in the bank after the closing. Now, those things do not matter.

Most lenders will not take a loan with a FICO score under 620 and the new “good” score is currently 720. So, if your score is not over 720 you can still get a loan, as long it is not under 620-you will simply pay a higher rate. Of course there are lenders out there that will budge on that, but be careful which promises you follow.

Shopping for a Mortgage

Frugal Dad: Where is the best place to shop a mortgage for first-time home buyers? Current bank? Mortgage broker? Online?

Dale: The other day I was misquoted in the Tribune as saying do not use a mortgage broker to shop for a loan. I received hate mail from a bunch of Texas mortgage brokers and had to convince them that, being a mortgage broker myself, I did not specifically say that. What I did say was that the consumer needs to take responsibility for themselves and shop for a loan with the best interest rate themselves. I truly believe that no one is too busy, too important or too dumb to put their financial future in the hands of one person and must always be checking the information provided to them. (Think if Bernie Madoff was also providing mortgages to his chosen clients.)

When shopping for a loan, one should never use the internet as more than an educational tool. The internet is a fabulous world for loan terminology and mortgage calculators, but why would you get a mortgage from a provider that you found in cyberspace? Companies such as Lending Tree, Quicken Loans and others, are more so lead generating companies for the mortgage industry rather than direct providers. Remember free credit reports and loan qualifications come with a price tag. This price being your information is being sold to a loan officer somewhere that will hound you to get your mortgage through them.

So, now that I have told you where you should not get a loan, where should you go to get a mortgage? There are the commercial banks, such as Bank of America, Wells Fargo and the like. They are great big institutions which have lots of loans to choose from and competitive interest rates. What they also have are departmentalized loan processing systems and voicemail. So, if you have the patience to call around, shop for a rate and deal with many different people through the loan process then a large bank would be for you. Next, we have the smaller regional community banks known as savings and loans. They work just like the big banks do, but you might get more personalized service. Again, shop around and ask a lot of questions.

Third party mortgage providers are mortgage bankers and brokers-like me. Having assisted with over 65% of all mortgages obtained over the past five years, they were a big part of the real estate boom and bust that we have seen.  These companies are not the direct lenders and simply provide a service of assisting the consumer with getting a mortgage with hopefully the lowest interest rate. Their job is to shop your loan and work with you and all the parties involved from beginning to end. For this, they receive a fee from the lender your mortgage ultimately goes to. It is a win-win for all if you are working with a professional and honest broker.

The fact is that no matter what institution you get your loan from it is the loan officer you choose that should be the big decision. I believe it does not matter where I work, whether a bank or a self employed mortgage broker. It is my experience, stability and integrity that makes me a good loan officer. A consumer should choose carefully who they want to use based on a series of questions and how the loan officer handles that conversation. Think of the initial conversation with a potential loan officer as a first date. If it does not go well, why go out on a second date? There are a lot of fish in the sea!

Paying Off a Mortgage Early

Frugal Dad: We frugal people like the idea of living without a mortgage. What are your thoughts on paying off a mortgage early?

Dale: Frugal living in my book, means living within, or below your means. It means not buying that 56-inch flat panel and paying it off over time, not driving the expensive car because they offered you 0% interest rate on a 60 month loan and not going out to dinner every night of the week. Frugal living means thinking before you spend money on something you need or already have, being able to save every month and having a reserve fund on hand in case you lose your job or have an unforeseen expense.

Living mortgage free is more of a luxury for those frugal followers. Since most people cannot buy a home without a mortgage and there is a tax benefit for writing off the mortgage interest, it is not such a bad thing. In other words don’t feel that you need to buy a home for cash, pay off your mortgage as quickly as your credit card or keep renting if you cannot afford to buy a home.

Assuming one can afford the mortgage payments, I love to suggest accelerating them. One extra mortgage payment per year knocks a 30 year mortgage down to approximately 24 years and a few months. One extra payment can be made as adding 1/12 of the monthly payment to each month, paying one total extra payment to the lender each year or making a ½ payment every two weeks. Anyway you do it, it adds up to a total of 13 payments a year. The saving in interest is approximately 1/3 of the total interest for the life of the loan. Knocking off this much interest equates to lowering your effective interest rate by almost 2%! This is a huge savings for the borrower and paying it off early is a gigantic satisfaction.

Any way you want to look at it; homeownership is a luxury and is not meant for all. The American Dream is a dream not an entitlement.  A home is typically the largest single asset one owns and should fit nicely into the entire financial picture. Remember the whole is only a sum of the parts and this part should not be too big as to swallow up everything else. With times the way they are today, the consumer should be much more vigilant, diligent and responsible in their homeownership and mortgage selection. Moving forward, there were lessons to be learned by all and hopefully we will not forget what happened in the past when making future decisions.

End of interview.

I’d like to thank Dale for taking the time to answer my mortgage questions, and I wish her much success with her book. In fact, she was nice enough to send me a copy of her book, which I’ll be reviewing here at Frugal Dad in the next couple weeks.

More About Dale

Dale Robyn Siegel is a licensed attorney in New York and owner of Circle Mortgage Group, a boutique mortgage broker in White Plains, New York. She is an adjunct professor at Baruch College as well as NYU Schack Institute of Real Estate.

Dale has been speaking to the public and teaching real estate professionals about mortgage finance for the past ten years. You can learn more about The New Rules for Mortgages at TheNewRulesforMortgages.com, and you can purchase a copy at Amazon.com or visit her virtual book tour.

We are still in the midst of what most would consider a great time to buy a house. Benefits are plenty for first time home buyers and those looking to trade up alike, including sizable tax credits and low interest rates. I personally know a number of people currently renting a house that are finally considering buying a new home.

One argument used to convert renters to homeowners is a side-by-side comparison of mortgage payments to monthly rent. Realtors often like to tell potential buyers that renting is like “throwing money away.” I happen to disagree with that logic, and think renting makes a lot of sense in certain scenarios. Considering the lessons we’ve all learned from the 2008 real estate bubble, building equity is no longer a sure thing either.

Comparing rent to mortgages and declaring mortgages a cheaper option is to compare apples and oranges. Let’s assume a potential home buyer is considering two houses of equivalent square footage. One home rents for $1,000 a month. The other home could be financed with a principal payment of $1,000. Based on these two costs alone the deals look equal, however there are a number of other factors to consider.

Property taxes. One of the benefits of renting is that you are not responsible for paying property taxes on the home. The bill still comes to your landlord. Of course, if you own a home you get a tax deduction on mortgage interest, but depending on your income this may or may not be a wash.

Insurance. Homeowners insurance is practically a requirement when buying a home (in fact, most mortgages require it to underwrite the loan, and even if they didn’t it is still a good idea). Renters should investigate renters insurance as it is typically very cheap relative to the contents of your rented home. Since renter’s insurance is usually cheaper than home owner’s insurance, renters have a slight advantage here.

Maintenance/Repairs. This is the big one. Hot water heater bursts in the middle of the night and floods your utility room. Who pays for the repairs and cost to replace the water heater? If you own the home it will come from your emergency fund (hopefully). If you rent, a quick call to the landlord is all that’s required and they are on the hook for repairs.

Same for ongoing maintenance of the property. Landlords are responsible for things like painting or replacing siding on the exterior of the home, putting on a new roof, and any other updates required over the years. Renters are typically responsible for things like lawn care and keeping the interior in good shape (walls, carpet, etc.).

For this reason, it is important to have a solid emergency fund before taking the plunge into home ownership. Take it from me, if you buy a home without much in savings, something expensive will break within the first 90 days. It’s a sure bet. If it can happen, it will.

Freedom. Even though freedom is not a tangible cost of renting or home ownership, it is still a very important factor when choosing where to live. Renters typically sign a lease or rental agreement for a specified time (usually one year). Most people who buy a home sign a 30-year mortgage, and unless they pay off the mortgage early, they will be stuck with the debt for decades to come.

Guess who can pick up and move easier if the local economy sours? Guess who can move to a different part of the country if they decide the heat/cold no longer agrees with them? Yep, it is the renters. Buying a house is a big commitment, and if you are still unsure about planting roots in your community, job, etc. then it might make sense to rent a little longer.

It is a great time to buy a home with plenty of inventory, motivated sellers, tax incentives and low rates. But none of those things matter if you are not in an position to buy. Resist taking on the added responsibility, and the debt, if you are not ready.

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It’s easy for a first time home buyer to get lost in translation when swimming in the sea of mortgages. Common questions of first time home buyers are “what mortgage is right for me? What are the benefits and downsides of certain mortgages? How much will I end up paying in interest payments over the long term? How much can I expect my monthly mortgage repayment to be?” If you are a first time home buyer who is simply trying to get a brief education on the most popular mortgage, a fixed rate mortgage, I’ve got you covered. Here is an in depth, yet simple to understand, review of the fixed rate mortgage.

Steady Mortgage Repayments

Fixed rate mortgages are the most popular mortgage choice amongst home buyers known to date. Fixed rate mortgages allow for borrowers to pay their mortgage repayments on a set monthly amount that will not be subject to change over the course of the mortgage repayment process. For example, if you purchase a home today under the term of a 30 year fixed rate mortgage and your current monthly mortgage repayment is $1,400 per month, twenty five years from now your monthly mortgage repayment will be the same amount.

Interest First

The most popular fixed rate mortgage term is a 30 year term. However fixed rate mortgages are available in terms as short as ten years or as long as fifty years. The mortgage repayment structures for fixed rate mortgages are designed to primarily pay down the interest payments that were paired with the initial mortgage.  However attractive loan officers may have packaged fixed rate real estate auctions, their efforts fail to mask the biggest defect of this mortgage system. The defect is that borrowers end up paying the creditor far more than 100% of their loan’s principal in interest alone.

Sandra the Home Buyer

For example, let’s say Sandra purchases a home in January of 2009 and borrows $250,000 under a 30 year term and has been given an annual interest rate of 8%. At the end of the 30 year term, Sandra has paid a total of $660,387.60. Exactly how much of that money has gone towards interest payments? A total of $410,387.60 has gone towards interest payments; which is 164% of the principal.  Throwing around all of these numbers is probably not the most eloquent way to get my point across. In order to minimize confusion, I’ve provided a screenshot of the example.

If you enjoy the security that a fixed rate mortgage provides, you are not alone. If you are okay with paying practically twice your home’s actual worth in interest payments alone, you are sitting by yourself in an abandoned town.

Most home buyers who fall into the trap of the fixed rate mortgage fit into one of two categories. Category A) the buyer is desperate to purchase a home and has been declined by every other mortgage application aside from a fixed rate mortgage. Category B) the buyer failed to translate the 8% interest rate per year into the accumulated interest rate over the entire loan term.

Editor’s Note: Jazmin’s example represents an extreme example assuming an 8% interest rate. Current rates are far lower for borrowers with good credit, but there are still some products on the market that look a lot the old “sub-prime” mortgages with interest rates much higher. If you can’t borrow at a more competitive rate, I would submit that you cannot afford to buy a home. As Jazmin points out – it is simply too expensive. Remember, there is no shame in renting!

Jazmin Espinal is a professional freelance writer and the owner of Capital Web Writing, a web content solution for businesses and webmasters. To contact Jazmin or to see samples of her writing, please visit CapitalWebWriting.com.

In a typical week I receive variations of this same question several times via email, comments and from followers on Twitter: “Should I Pay Off Mortgage Early?”  For the most part, my answer is, “It depends.”  But on a few occasions, when people share more details of their overall financial plan, I tell them to go for it.  Pay off your mortgage early and live in that home free and clear!

Having a mortgage is one of those culturally expected things, along with car payments and credit cards.  Most financial gurus fall backwards out of their chair when you mention paying off your mortgage early, instead of plowing more dough into their carefully selected portfolio of investments – most of which are not properly aligned with your risk tolerance, nor your overall investing strategy.

The market downturn, which apparently is still turning, seems to have more and more people reevaluating the question, “Should I Pay Off My Mortgage Early?” Up until now conventional wisdom said no. Invest that money in the market, and keep paying interest to the bank to get the tax deduction. Now I’m not so sure. Seems to me like we would have been better off to be sitting here with a paid-for house than a handful of worthless investments.

That is basically what Steve was alluding to in a post that caught my eye some time ago, “What If Saving Was Stupid?” One of the more profound statements was that “money in the market isn’t saved – it’s invested, and investment carries a risk that it won’t be there when you need it.”  So true; as many of us have had the recent misfortune of discovering.

But paying off debt, including your mortgage, is a sure thing.  Assuming you are not borrowing any new money, paying off $50,000 in debt means that $50,000 debt can never come back.  It doesn’t matter what the market does.  It doesn’t matter if we are at war or in peace time.  It doesn’t matter how strong or weak the U.S. dollar is – that debt is never returning to your personal balance sheet.  To me, that is a powerful incentive to use the $50,000 to pay off my mortgage early.

Sure, I could invest that same money in the down market and watch it go to $60,000 by next year.  But that is far from a sure thing.  Besides, without a mortgage I could easily start dropping $1,000 a month into investments.  It wouldn’t take very long at that pace to hit $60,000 in investments. And if you really liked having a house payment, you could always refinance your mortgage.

What this question really gets to is your tolerance for risk, and your dreams for the future.  I hope to “retire” from working for money earlier than most people, and I cannot do that with a mortgage payment.  So for me, thirty years of payments is not an option.  With a paid-for house, and very few expenses, retiring would be a much more viable option because it would not take much in the way of earnings to sustain a frugal living.

The last couple years have proven to be tough times to be a homeowner. Home values around the country have seen a decline, and many homeowners are now feeling the squeeze from signing up for adjustable rate mortgages.  Many homeowners are having a hard time coming up with mortgage payments, while meeting minimum payments for cars and credit cards (even low interest credit cards often have high minimum payment requirements of 2-3% of the outstanding balance).  Something has to give, and all-too-often it is the house that falls behind.

The Squeaky Wheel Gets the Oil

There are too many stories out there about homeowners who kept their credit cards current as they fell behind on their homes, ultimately leading to foreclosure.  Credit card collectors are notorious for their obnoxious, high-pressure techniques, and unfortunately they are also often the most successful.  I used to work in a call center, and I’ve seen these collection practices up close and personal.  Believe me, it wasn’t any more fun for me being on the other end of the line, but some people seem to enjoy abusing others over the telephone.  I was raised on the idea that you catch more flies with honey than with vinegar, but in the collections world this just isn’t true.  The best way to collect money on a credit card is to scare the cardholder into thinking they will be sued, or to pester them to the point that they finally pay just to get you out of their lives.

Shelter and Transportation Before Capital One or American Express

The problem with paying credit card companies when you are in a financial bind is that with only so much money to spread around, something else is going to suffer.  I’m not advocating you neglect to pay a just debt, however I am advocating that you sit down with the pile of money you have to work with and put life necessities at the top.

I’m a fan of the Dave Ramsey radio show. I don’t agree with 100% of what he advises, but he is right on when it comes to this subject.  When he fields calls from people who are being bullied by credit card collectors he advises them to list out their monthly expenses beginning with life-sustaining expenditures first:

• Housing
• Food
• Lights
• Transportation

Notice credit cards weren’t part of that lineup.  If you have money left over after paying those four basic categories, then by all means make your credit card minimum payments.  If you don’t have anything left over, do not stress out about what Bank of America might do to your FICO score, or worry that Discover Card is going to garnish your wages.

If you receive a call from a nasty credit card collector, explain in a calm manner that you have budgeted your bills for the month and unfortunately you are not able to make a payment this time.  When they start to scream and yell and call you names, simply put the phone down on the table and go about your business.  If you get emotional and yell back at them, they win.  Getting you upset is their objective, so don’t let them win!

When your financial situation improves make plans to catch up on outstanding bills, again putting credit cards last.  House and car payments come first, and with anything left over you can begin to catch up on outstanding credit card debt.  The bottom line is to play by your rules, not the credit card collector’s.  After all, you are the one that has to suffer the consequences of missing a house payment, or getting your car repossessed.

One of the most controversial subjects around the family finances is the decision to payoff the mortgage early.  Some say you should keep the mortgage around as long as possible, citing low interest rates and tax deductions as opportunities you are giving up by paying it off early.  Others enjoy the freedom that comes from no mortgage payment, and the huge amounts of disposable, monthly cash that comes along with being mortgage-debt free.

Life Without a Mortgage

Can you afford your mortage? I don’t mean can you afford your mortgage payment, I mean can you afford to even have a mortgage considering all you’re giving up to finance a home?  Mortgages are sort of a necessary evil nowadays, mostly because real estate is too expensive for the average person to pay for a house with cash, but in some cases because people buy more home than they can really afford.  In many cases people could nearly pay for a home in cash, or at least put 50% down, if they would settle for a smaller place.  Of course, some in extreme real estate markets would argue even this plan is impossible with modest homes starting in the $400,000 range.  I would agree.

Still, it is hard not to enjoy the idea of not owing anyone any money.  Imagine the freedom that comes with being debt free, including the house and all credit cards.  Let’s say for example that you are in your late 40’s, and your kid(s) are wrapping up college.  Instead of carrying out that thirty-year mortgage to the full term you worked to pay it off in twenty years.  Now you own a $200,000 paid-for home, and have no other debts. And if you really liked having a house payment, you could always refinance your mortgage.

At this stage in your life, could you seriously consider an early retirement?  Would a career change, or relocation now seem plausible?  Of course!  With no payments you simply have to earn enough to cover your basic needs such as food, lights, insurance, etc.  And assuming you had adequate savings there is nothing stopping you from going after the career you’ve always wanted, but could never afford.

But Couldn’t I Earn More in the Markets?

Maybe.  At the time of this writing the markets are doing so hot, so passing on extra mortgage payments to invest in a flat (or declining) market doesn’t yield the kind of returns you might expect in a bull market.  The flip side to that is that when markets are in a decline it is a good time to stock up on beaten up companies with solid fundamentals, so setting aside some money to invest does makes sense.

I try to look at things through a short-term-pain, long-term-gain filter.  I may have to miss out on a few hot investments now, but down the road I’ll be able to make huge contributions to retirement funds and taxable savings vehicles if I have no debt payments.  I’ll also be free to make more decisions about how to spend the remainder of my life energy, rather than continuing to work in a passionless career just to make a house payment.

If you are looking to refinance, check out Mortgage 123 to lock in record low rates today