DTI, APR, "hard" versus "soft" credit pulls, and more.

By Perri Ormont Blumberg
April 27, 2021
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Andy Taylor, GM of Credit Karma Home knows home finances. As for us, sometimes our heads start to spin when we hear phrases like DTI and hard credit pulls thrown around. But fear not, whether you're a first-time home buyer or have bought a home before but need a refresher, Taylor has got you covered. Below, he breaks down five common mortgage-related phrases and what they mean.

Debt-to-Income Ratio (DTI)

Ah, so that's where "DTI" comes from — debt-to-income ratio. "Debt to income is the ratio of your monthly expenses (your debts) to the amount of money you bring in each month. Your DTI accounts for your monthly debt payments divided by your gross monthly income, which is your take-home pay before taxes or other deductions are taken out. This means it weighs how much you owe each month against how much you earn," says Taylor. "If you include expected monthly mortgage, insurance and property taxes, your DTI helps a lender understand how much cash you'll have left over after you've paid your housing expenses, and other expenses like credit card bills," he continues, adding that your DTI is an important factor because it shows a lender that you won't be using up all of your remaining cash on making your house payment.

"There are two main ways to lower your DTI ratio -— reducing your monthly debt or increasing your income," he adds. Need some money-saving help? Check out nine habits of Southerners who are good at saving green.

Mortgage Pre-approval 

"When getting approved for a mortgage, there are two ways a consumer can improve their chances of getting approved: getting pre-qualified or getting pre-approved. It's really a spectrum, and the two terms are sometimes confusingly used interchangeably, depending on which lender you're talking to," Taylor explains. "The primary difference between the two is in the amount of information provided by the borrower, and the level of validation across that information. For example, does a lender take your word that you're a multi-millionaire, or do they actually verify that by looking at your bank statements?"

So how much grunt work is involved? It can actually be pretty cut-and-dried. "Getting pre-approved is a fairly straightforward process that requires some paperwork and, in many cases, just a few days for the lender to verify your personal and financial information. Plus, going through the pre-approval process could help alert you to potential problems that may prevent you from getting a mortgage down the road," he says. "If you don't get pre-approved, you'll have clarity into what you need to improve before you begin your home search. This could entail paying down debt to improve your debt-to-income ratio (DTI), saving for a larger down payment, or resolving inaccuracies on your credit reports."

Taylor notes that once you complete the pre-approval process, you'll receive a pre-approval letter from your lender, which is usually good for 30 to 90 days. "In today's seller market driven by a low housing supply, getting pre-approved is more important than ever in terms of competition and showing the seller you're a motivated and capable buyer," he comments. 

Hard Credit Pull v. Soft Credit Pull

"Hard or soft? No, we're not talking about how ripe that avocado is, we're talking about two different ways of looking at your credit file. Typically, a lender will want to do a 'Hard' pull prior to getting you pre-approved or actually funding a loan because it shows more information," Taylor says. "However, this comes with the price of dinging your credit score, usually around nine points on average. A 'Soft' pull can often be used instead, especially earlier in the process to give a lender a good sense of your credit worthiness, but without that pesky credit hit."

Taylor's top tip? Don't let these hits on your credit score keep you from shopping around for a mortgage. "You should still compare rates and terms from different lenders before committing to a new loan. If you're worried about multiple requests or inquiries dinging your credit score, understand that any impact to your score will be small, and you can minimize any negative impact by shopping in a short period of time," he says. "Complete your mortgage shopping in 14 days, and when multiple lenders request your credit score within that time, it will only count as a single inquiry. That window could be as much as 45 days, but the rules can vary depending on what scoring model lenders use, so 14 days is the recommended, safe bet."

Fixed v. Adjustable-Rate Mortgages (ARMs)

Trying to determine what kind of loan is right for you? Taylor says it's important to consider your overall financial goals, budget, and assets. "A fixed-rate mortgage locks in your interest rate for the entire loan term, which typically ranges from 10-30 years. It's common for first-time homebuyers to choose a 30-year fixed-rate loan because of the long-term predictability," he says. "Interest rates are typically lower on shorter loan terms, but the payments are higher because of the shorter repayment period. If you plan to stay in your home long-term, it's a great opportunity to lock in a 30-year fixed mortgage at today's low rates."

As for adjustable-rate mortgages or ARMS, they have an interest rate that may change over time. "Typically, under an ARM, the interest rate will remain the same for five to 10 years, and then adjust annually after that. ARMs are popular for refinancing, particularly for borrowers who plan to sell their home or fully pay off their loan in the near future," he says.

Interest Rate v. Annual Percentage Rate (APR)

Now's the time to get acquainted with what each of these terms means: "Understanding the difference between these two terms is important when shopping for a mortgage to ensure you are picking the best loan for your financial situation. A mortgage interest rate is a small percentage that's applied to your loan balance to determine how much interest you pay each month," shares Taylor.

"An APR encompasses all the costs of financing a loan, so it will typically be higher than the mortgage interest rate (some loan financing fees that are typically included in an APR includes mortgage broker fees, mortgage insurance, application and processing fees, and more). When reviewing loan estimates, do not compare a mortgage rate to an APR because it's not an apples-to-apples comparison, instead, compare rates to rates and APRs to APRs," he says,

There won't be a quiz, but knowledge is power, dear readers. So make sure you brush up on all these phrases if you're currently fielding emails from realtors, daydreaming about your new breakfast nook, and getting ready to move into your new home.