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What is Payment Shock
What is considered payment shock by mortgage lenders. How do lenders calculate payment shock. What is considered low payment shock. How is low payment shock considered a compensating factor. Can you give a few case scenarios of payment shock.
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What is the meaning of Payment Shock?
Paying shock means a sudden and substantial increase in housing costs homeowners incur when transitioning from rental to ownership. Lenders gauge this payment surge by determining how much more one has to pay for their new mortgage than before – rent or an existing loan.
How do Lenders Calculate Payment Shock?
To calculate payment shock, lenders work out the percentage increase that it represents:
- Payment Surge=New Mortgage Payment−Current Payment Divided By Current Payment × (Multiply by 100)
Let’s say you have…
Low Payment Shock as a Compensating Factor:
Suppose the rise in monthly installments under a fresh mortgage is similar to what a borrower was already used to paying. Such low payment shock can compensate for risk factors like high DTIs (debt-to-income ratios) or poor credit scores. This implies the individual knows how to manage a similar amount, reducing the lender’s risk exposure.
Case Studies about Pay Surges:
High Payment Shock: Take the example of someone who currently pays $1K monthly rent but plans on buying a house, which will require them to cough up $2,500 per month towards servicing their mortgage. In such a scenario, the percentage would be 150%, which might worry lenders.
Medium Payment Surge: Suppose an occupier spends $1,500 every thirty days renting an apartment and later decides to purchase the same unit through financing. According to the terms given by their lender, they will be asked for $1,800 each month as repayment; in this case study, we are considering 20%, which is considered manageable due to its low value.
Low Payment Shocks: Let’s take the example of a homeowner currently servicing their home loan at $2,200 per month who refinances into another credit facility charging an equivalent interest rate. This only saves them an additional $100 during the first year of repayment. Then, the shock comes out to be 4.5%, likely seen as a positive compensating factor by the lending institution.
Understanding payment surges makes it easier for lenders to evaluate whether borrowers can afford a new mortgage, considering their financial situation.