What is Payment Shock?

Written by Posted On Tuesday, 26 July 2022 00:00

In general, payment shock as it relates to mortgages typically means a big difference between what you're paying now in rent compared to what a new mortgage payment would be. For example, if you're paying $1,000 per month for rent and your new mortgage payment, including taxes and insurance, goes to $1,250, that's a 25% increase. This is within an acceptable range. However, if the payment goes from $1,000 per month to $2,000 per month, it might cause an underwriter a bit of concern.

What's the general threshold for payment shock? There is no universal guideline however most lenders don't want to see the new payment be more than 200% of the current rent. Different lenders can set different payment shock standards for their own company. Even if someone's debt ratios still fall in the proper range, doubling a monthly payment might cause an underwriter to further evaluate the application.

Remember, payment shock isn't an automatic disqualifier but will be considered regarding the full scope of the application. When evaluating possible payment shock, lenders take a look at credit scores and liquid assets. Higher credit scores can allow for payment shock adjustments. However, if credit scores are lower, the lender will be more inclined to turn down the loan.

How do you address potential payment shock? The obvious answer is to buy and finance a smaller home. Payment shock is also influenced by property taxes and homeowners insurance as well as private mortgage insurance when needed. There's not a lot buyers can do with regard to property taxes but do have the ability to shop around for insurance policies. If you anticipate a payment shock issue, it can pay to include a private letter explaining your current situation and that you'll be comfortably able to make the new payments.

Payment shock applies to both fixed rate loans and adjustable rate mortgages. Shorter term fixed rate loans will have higher monthly payments, even though the amount of long term interest is reduced. Adjustable rate mortgage payment shock applies to the fully indexed rate and not the initial start or 'teaser' rate. Lenders will look up the current index, and the accompanying margin and use that figure as the payment shock tolerance level.

Borrowers might also feel very uncomfortable with such a large increase in payment, again even if current and future debt ratios are in line. If someone is paying $1,000 per month and the new payment will go to $2,000 per month, they might take a closer look at their comfort level and decide not to move forward on their own. 

Again, there are no universal payment shock guidelines as lenders can set their own internal policies. If one lender turns down a loan application due to payment shock that doesn't mean all lenders will be at the same level.

Rate this item
(1 Vote)
David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

Realty Times

From buying and selling advice for consumers to money-making tips for Agents, our content, updated daily, has made Realty Times® a must-read, and see, for anyone involved in Real Estate.