Generally, Front-End Debt-to-Income Ratio is used by lenders, and it is alternatively called mortgage-to-income ratio. It is calculated by dividing the monthly mortgage instalment by the monthly income. This ratio assesses the borrower debt servicing commitment relative to the monthly income.
The back-end ratio is also termed as debt-to-income ratio, indicating part of monthly income of an individual that is used for debt payment. The ratio is calculated as (total monthly debt expense / gross monthly income) X 100. This ratio is also used to evaluate the risk level associated with money lent to a prospective borrower.
What is a Jumbo Loan? A jumbo loan, also known as Jumbo Mortgage, is used to finance a loan or a mortgage that is too expensive compared to a conventional loan or exceeds the limit placed by Federal Housing Finance Agency (FHFA). A jumbo loan allows access to those assets or property spaces which would otherwise not be a feasible purchase option for the borrower. However, jumbo loans are much riskier than conforming loans as they are not insured and should be opted for only after prior consideration. Conforming loans are mortgage loans that meet the guidelines of Fannie Mae and Freddie Mac, the home mortgage companies that are federally backed. These loans must conform to financing limits set by the Federal Housing Agency. How are jumbo loans issued? Jumbo loans are used to finance luxury houses as well as houses priced in more expensive areas. However, to be eligible for a jumbo loan, high credit score of borrowers is required. Borrowers must also fall in the high-income bracket. How are Jumbo Loans Different from Conforming Loans? Jumbo loans and conforming loans are both used by individuals to finance their purchasing needs. Both these loans require certain eligibility criteria to be met like minimum credit scores, income thresholds, repayment ability and down payment commitments. However, despite these similarities, they have differences too. Conforming loans are usually sold to Fannie Mae and Freddie Mac, this mandates them to adhere to the limits set by these federal government-sponsored enterprises. Unlike conforming loans, jumbo loans are not required to follow these restrictions. Thus, they are nonconforming loans. Additionally, jumbo loans are used to finance those purchases which are expensive but conforming loans can be issued for consumption needs of the average homebuyer. Another difference is that jumbo loans are issued for high income groups. However, almost all borrowers are eligible for conforming loans, provided they fulfil the requirements set by the issuer. What are the requirements that must be fulfilled to secure a jumbo loan? Jumbo loans end up being a riskier borrowing option, thus, lenders may tighten the restrictions that make borrowers eligible. These restrictions include the following: Income Proof: Since jumbo loans are only issued to wealthy borrowers, the proof of income is a must to secure the loan. To secure future repayments, lenders may ask the borrowers to present tax documentation as well as proof of assets held by them. Credit score: A strong credit score enables lenders to be assured of the fact that the borrower will not default. Most conventional loans can be issued to borrowers holding a “fair” credit rating. However, to be eligible for a jumbo loan, borrowers must hold a credit rating higher than the “fair” rating. Debt-to-income Ratio: Consumers may be asked to hold a certain debt-to-income ratio before being able to qualify for a jumbo loan. Jumbo loans can be a good option when the capital requirement of the borrower exceeds the limits set by conforming loans. Therefore, borrowers in need of high-capital loans can opt for jumbo loans. Another added advantage of jumbo loans is that they can be issued without a down payment. What are the disadvantages of jumbo loans? Jumbo loans are more expensive: Jumbo loans often require a hefty down payment, which is considerably higher than the down payment required in the case of conventional loans. Sometimes, the down payments required by jumbo loans may be as high as 20%. However, these down payments may not be necessary always. Higher interest rates: Jumbo loans tend to remain expensive throughout all the stages. Higher interests are charged in a jumbo loan, which may seem very daunting to many people. This may make them seem riskier than Fannie Mae and Freddie Mac. This happens because lender expects greater returns for giving out jumbo loans. Higher closing costs: Jumbo mortgages often involve high closing costs as compared to conforming loans. Jumbo lenders may also only give out loans for those underlying assets which are valued high enough for them to issue a jumbo loan.
While investing in a managed fund, the fund management company charges a fee when initiating an investment into the fund. Assuming an investment of $1000 in a fund, and the fund has a front-end load of 1%, it means that $10 would be charged as fees and $990 would be invested in the fund.
What is a Housing Bubble? A housing bubble occurs when the prices of real estate or housing rise at an increasing rate because of increased demand and lack of adequate supply. This may also occur when there is emotional buying in the markets. Once this rise in price is realized by the market players, the bubble tends to rise further as more buyers enter the market. However, investors and speculators are aware that the prices would eventually come down as the property market gets overvalued. Thus, this phenomenon was given the name of a “bubble” as it is eventually expected to burst. How does a housing bubble occur? There are various factors that contribute to a housing bubble. During the boom phase in the economy, usually households have more money to spend. With greater disposable income, people may spend more on housing. Thus, people are willing to take on debt during such an expansionary phase. Additionally, if interest rates are low then consumers are tempted to buy more on credit. Thus, the economy develops a greater appetite for risk. This can quickly lead to the economy spiraling out of control. At such a time, there can be high levels of speculation and risky behavior. This can eventually lead to a sharp rise in prices. Thus, an inflationary pressure sets in on the real estate prices. How do market players become aware of the bubble? A bubble is expected to set in when the price of a commodity or asset is much higher than what the commodity or asset is worth. This actual worth of the commodity is known as the benchmark. However, there may not always be a defined benchmark for all types of assets. The benchmark is only an estimate based on a collection of variables affecting the supply, demand, and price of the commodity. Some of these variables may include population growth, average income, average household size, etc. It may be difficult for different speculators to reach a common ground while determining the threshold price of the commodity/asset. However, there are certain methods that are acceptable by a majority. One such method is finding long run averages based on the historical data. If asset prices overshoot these averages or the trend, then there may be a bubble present in the economy. However, any small spike in asset prices may not directly be termed as a bubble. It is only when the asset prices reach outrageous levels that speculators and investors declare that a bubble is persisting in the economy. Is it possible to predict a housing market bubble? Most bubbles, including housing market bubbles are only discovered in hindsight. Thus, it is extremely hard to predict when the next bubble might arise. However, there are always some warning signs that can be paid attention to. Economists have tried to base this estimation on certain indicators that can help identify bubbles in specific areas. The first step is comparing current prices to the prices seen during historic boom cycles. This lays out an idea about whether the current prices are showing a similar trend as before or not. There are other indicators falling into two broad categories: valuation and debt. Valuation is done by finding out the price to income ratio to determine the percentage of income people must pay to buy a house on credit. Whereas the debt side is measured by finding out the debt-to-income ratio or the total cost of home ownership relative to a family’s income. What impact does a housing bubble have on the economy? A bubble can affect the real estate markets, personal wealth, and the economy overall. Bubbles can make everyday items more expensive, as well as rack up the prices of mortgages. Consequently, homeowners may be compelled to dive into their retirement plans. The housing bubble, once it pops, can cause severe damage to all sectors in an economy. As people are trapped in the bubble, they keep expecting prices to go on increasing. Thus, people may end up buying more than what they can afford. How does such a housing bubble pop? The pop eventually comes when increasing supply remains unmet by decreased demand. Due to consistent growth in the home prices, buyers now become wary of paying higher amounts. Additionally, many homeowners end up borrowing more than what their house is actually worth. Thus, when prices start to slide, homeowners may realize they have landed in a debt trap which becomes extremely hard to come out of. This can lead to increased foreclosures, which drives the housing prices further low. Due to increased risk-taking, the economy enters a saturated space where it can no longer cater to the increasing supply. Once the bubble pops, investors can buy when prices reach their lowest. This would allow investors to buy more property for a given amount of money. What is an example of a housing bubble? The most prominent housing bubble was the one observed in 2007-08 crisis. The real estate bubble had begun during the early 2000s and came to a crash during 2008. Housing prices had shown a peak in early 2006, which eventually started to subside in 2007. However, the full effect of the crash was visible in 2012 when prices reached rock bottom. During the coronavirus pandemic, prices seem to be overvalued in various states within the US. However, it is difficult to estimate when such a bubble of would again be seen in the county.