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Mortgage_Management_for_Dummies_----_Part_1_Getting_Started_with_Mortgages1.pdf
CHAPTER 2 Qualifying for a Mortgage 25
Chapter 2
IN THIS CHAPTER
» Starting off right with preapprovals
» Understanding how lenders size up borrowers
» Solving typical mortgage problems
Qualifying for a Mortgage
W e love a good thriller. If you’re looking for a spine-tingling mystery, however, Mortgage Management For Dummies isn’t it. Qualifying for a mortgage shouldn’t be the least bit mystifying. And after you understand how lenders play the game, it won’t be. This chapter removes nearly every bit of puzzlement from the process. We show you exactly how to get started, tell you what lenders look for when evaluating your creditworthiness, and help you solve your mortgage problems — whether you’re looking for a loan as a first- time homebuyer or trying to refinance or pay off your mortgage faster.
Getting Preapproved for a Loan Everyone knows that time is money, so we decided to begin this section with a timesaving tip. If you’re a homeowner who wants to refinance an existing mortgage, you have our permission to proceed directly to the next section, which discloses how lenders evaluate your credit. This segment applies only to folks who haven’t bought a house yet. (Don’t feel slighted. We devote Chapter 11 entirely to the fine art of refinancing.)
Now, for all you wannabe homeowners, be advised that there’s a right way and a wrong way to start the home-buying process. The wrong way, astonishingly, is rushing out helter-skelter to gawk at houses you think you may want to buy.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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26 PART 1 Getting Started with Mortgages
Don’t get us wrong; knowing what’s on the market is important. It’s even more crucial to educate yourself so you can distinguish between houses that are priced to sell and ridiculously overpriced turkeys. If you don’t know the difference between price and value, you could end up paying waaaaaaaaaay too much for the home you ultimately purchase. (To find out everything you need to know about buying a home, check out Home Buying For Dummies, by Ray Brown and Eric Tyson [Wiley].)
But . . . first things first: If you can’t pay, you shouldn’t play.
The worst-case scenario Suppose you’ve been looking at open houses from dawn to dusk every Saturday and Sunday for the past seven weeks. Just when you begin to think you’ll never find your dream home, it miraculously appears on the market.
You immediately make an offer to buy casa magnífico, conditioned upon your approval of the property inspections and obtaining satisfactory financing. When the sellers accept your generous offer, the bluebird of happiness sings joyously.
Three weeks later, the bird croaks. The loan officer calls to regretfully advise you that the bank has rejected your loan application. The reason isn’t because you offered too much for the house. On the contrary, the appraisal confirmed that the property is worth every penny you’re willing to pay.
The problem, dear reader, could be you. Unfortunately, your present income and projected expenses may be out of whack. You may not earn enough money to make the monthly mortgage payments plus pay the property taxes and homeowners insurance without pauperizing yourself. Adding insult to injury, this depressing discovery is delivered to you after you’ve blown hundreds of dollars on property inspections and loan fees and put yourself through an emotional wringer for three weeks.
Now the good news: It doesn’t have to be this way. After you establish how much you can prudently spend for your dream home, which we cover in Chapter 1, the next logical step is to get yourself preapproved for a mortgage. Then you’re prop- erly prepared to begin your house hunt.
Loan prequalification usually isn’t good enough You can use two techniques to get a lender’s opinion of your creditworthiness as a borrower. One is the better way to go. The other is potentially a waste of your time and money and may even be grossly misleading.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 27
We start by critiquing the second-rate method. Loan prequalification is nothing more than a casual conversation with a loan officer. After quickly quizzing you about obvious financial matters, such as your present income, expenses, and cash savings for a down payment, the loan officer renders a down-and-dirty guessti- mate of approximately how much money he might lend you at current mortgage interest rates assuming that everything you’ve said is accurate. Most lenders graciously provide a prequalification letter suitable for framing or swatting mosquitoes.
Prequalification is fast and cheap. It rarely takes more than 15 minutes unless you’re the type who has trouble parallel parking.
Because the lender doesn’t substantiate anything you say, the lender isn’t bound by the prequalification process to make a loan when you’re ready to buy. When your finances are scrutinized during the formal mortgage approval process, the lender may discover additional financial liabilities or negative credit information that reduces your borrowing power. In that case, you end up squandering precious time and money looking at property you aren’t qualified to buy.
Loan preapproval is the way to go After you read this section, you’ll understand why formally evaluating your cred- itworthiness is such a protracted process. Loan preapproval is significantly more involved than mere loan prequalification.
Preapproval involves a thorough investigation of your credit history. In addition, the lender independently documents and verifies your present income and expenses, the amount of cash you have on hand, assets and liabilities, and even your prospects for continued employment. If you’re self-employed, the lender conducts a diligent analysis of your federal tax returns for the past couple of years.
Obtaining the credit report, verifications of income and employment, bank state- ments, and other necessary documentation usually takes at least a week or two. That’s time well spent. Getting preapproved for a mortgage gives you two huge advantages:
» You know how much you can borrow. Being preapproved for a loan is almost as good as having a line of credit when you start house hunting. The only thing the lender can’t preapprove is the house you buy. Because you haven’t begun looking at property yet, your dream home is still only a twinkle in your eye.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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28 PART 1 Getting Started with Mortgages
Be sure to stay in touch with your lender during your house hunt. The amount you’ve been preapproved to borrow is written on paper, not carved in stone. Lenders won’t give you a firm commitment on your loan’s interest rate until you actually have a signed contract to buy your dream home. If interest rates increase (or your employment income declines) after you’re preapproved for a mortgage, the loan amount decreases accordingly. By the same token, you can borrow even more if interest rates happen to decline (or you get a well-deserved pay raise).
» You have an advantage in multiple-offer situations. In a hot real estate market, you may end up competing with other buyers for the same property. Being preapproved is proof positive to sellers that you’re a real buyer. Your offer will be given far more serious consideration than offers from buyers who haven’t bothered to prove that they’re creditworthy.
Some lenders offer free loan preapprovals to prospective homebuyers as a mar- keting ploy to endear themselves to borrowers. However, others charge for loan preapproval. Don’t choose a lender only because you can get a freebie preapproval. Such a lender may not offer the most competitive rates, which could cost you far more in the long run. In Chapter 7, we take the mystery out of selecting a lender.
Evaluating Your Creditworthiness: The Underwriting Process
Suppose your best friend hits you up for a loan. If your pal wants to borrow five or ten bucks until payday, that’s no big deal. But if your acquaintance needs five or ten thousand dollars for a decade or so, you’ll probably analyze the odds of getting repaid six ways to Sunday before parting with a nickel!
Good lending institutions are even more careful with their depositors’ funds. They employ professional underwriters, who evaluate the degree of risk involved in loans that the lenders have been asked to make to prospective borrowers. In other words, underwriters tell the lender how much risk is involved in lending money to you. If they determine that you’re too risky, chances are you won’t get the loan. Under- writing standards are quite similar but do vary somewhat from lender to lender.
» Most lenders comply with underwriting guidelines of two institutions, the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). These lenders sell their loans on the secondary mortgage market to Freddie Mac or Fannie Mae, who then resell the loans to investors such as insurance companies and pension funds.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 29
» Portfolio lenders, who keep loans they originate instead of selling them in the secondary mortgage market, may have more flexible underwriting standards, but they may have higher rates or only offer adjustable rate mortgages.
Just because one lender turns you down doesn’t mean that all lenders will. If you’re having trouble getting a loan approved, head for a portfolio lender in your area. In addition to your own interviewing of lenders, a good mortgage broker can help you identify more flexible (portfolio) lenders; see Chapter 7. This section helps you navigate the underwriting process.
Traditional underwriting guidelines Underwriting standards can vary from lender to lender, because the underwriters who examine loan applications are flesh-and-blood human beings, not machines. Two underwriters can evaluate the exact same loan application and reach differ- ent conclusions (regarding the degree of risk involved in making the loan), because each interprets the traditional underwriting guidelines differently.
To get a mortgage, you must give a lender the right to take your home away from you and sell it to pay the balance due on your loan if you:
» Don’t make your loan payments » Fail to pay your property taxes » Let your homeowners insurance policy lapse
The legal action taken by a lender to repossess property and sell it to satisfy mort- gage debt is called a foreclosure. Lenders detest foreclosures. They’re typically financially detrimental and emotionally debilitating for everyone involved in the transaction, and they generate awful public relations for the lender. And, if a lending institution has too many foreclosures, state and federal bank regulators begin questioning the lender’s judgment.
Lenders constantly fine-tune the way they evaluate mortgage applications in search of better screening techniques to keep borrowers — and themselves — out of foreclosure. The sections that follow explain the primary factors that lenders have traditionally used to assess prospective borrowers’ creditworthiness.
Integrity Lenders look closely at you when deciding whether to approve your loan request. They want to know whether you’re a good risk. Will you keep your word? How great an effort will you make to repay the loan?
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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30 PART 1 Getting Started with Mortgages
One of the first things a loan processor does after you submit a loan application is order a credit report. Surprisingly, blemishes on your credit record aren’t always the kiss of death. Contrary to what you may have heard, lenders are human. They understand that financial difficulties related to one-time situations such as a divorce, job loss, or serious medical problems can smite even the best of us.
As we discuss in Chapter 10, all loan applications contain a “Declarations” section that’s chock-full of red-flag questions. For instance, this section asks whether you’ve ever had a property foreclosed upon.
As a result of the late 2000s housing market slump and mortgage meltdown, Freddie Mac and Fannie Mae issued extremely stringent underwriting guidelines for loan applicants who’ve had a foreclosure. In such cases, the application is manually scrutinized by underwriters probing for all facts related to the fore- closure. Check out Chapter 13 for more info on foreclosures.
If you answer yes to any of these red-flag questions, lenders want all the details. Even with the blemish of a bankruptcy or foreclosure in your credit history, how- ever, you’ll get favorable consideration from lenders if you established a repay- ment plan for your creditors. That commitment demonstrates integrity.
Conversely, people who’ve skipped out on their financial obligations are treated like roadkill. Lenders figure that if borrowers have cut and run once, they’ll prob- ably do it again.
Income and job stability From 2000 to 2006 during the peak of the residential lending frenzy, no doc or stated income loans were, regrettably, far too easy to get. No doc loans are loans made without written documentation for such things as the borrowers’ income, assets, and liabilities. Some borrowers claimed as much income as they needed to get their loan approved without having to substantiate their income. Lenders dis- paragingly referred to these mortgages as liar loans or pulse loans. If you had a pulse, you got a loan.
Fortunately, those reckless ways are mostly long gone. Now you have to not only have a job, but you also had better be able to prove it.
Lenders don’t want you to overextend yourself. They know from past experience that the number-one cause of foreclosures is borrowers spreading themselves too thin financially. Most lenders ask for your two most recent IRS W-2 forms to establish your gross annual income plus the last 30 days of pay stubs as proof that you’re still employed.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 31
If a lender can’t qualify you by using W-2s and pay stubs, the loan processor sends your employer a verification of employment (VOE) letter to independently confirm the employment information on your loan application, including your income, how long you’ve had your present job, and your prospects for continued employment.
Some lenders are more lenient than others are when they see that a prospective borrower has a history of job-hopping. All lenders, however, must be certain that you have a high likelihood of uninterrupted income. If you don’t get paid, how will they?
Debt-to-income ratio Lenders aren’t as concerned about short-term loans that you’ll pay off in fewer than ten months. They will, however, add 5 percent of any unpaid revolving credit charges to your monthly debt load.
For example, suppose you earn $4,000 per month. If your current monthly long- term debt plus the projected homeownership expenses total $1,200 a month, your debt-to-income ratio is 30 percent ($1,200 divided by $4,000).
If your debt-to-income ratio is on the high side, a lender puts your loan applica- tion under a microscope. Even if all your credit cards are current, the lender may insist as a condition of making the loan that you pay off and cancel some of your credit cards to reduce your potential borrowing power. Doing so reduces the risk of future default on your loan.
If you want to increase the odds of having your loan approved and accomplishing your financial goals, lower your debt-to-income ratio by paying off small loans and credit card debt and closing any unused open credit accounts prior to applying for a mortgage. An excessive number of open accounts reduces your credit rating.
Property appraisal Lenders must find out what the house you want to mortgage is currently worth, because the property is used to secure your loan. They do this by getting an appraisal, a written report prepared by an appraiser (the person who evaluates property for lenders) that contains an estimate or opinion of fair market value. The reliability of an appraisal depends on the competence and integrity of the appraiser. Equally important is having an appraiser with significant current mar- ket knowledge of the area and type of property being valued.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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32 PART 1 Getting Started with Mortgages
Loan-to-value ratio A loan-to-value (LTV) ratio is a quick way for lenders to guesstimate how risky a mortgage may be. LTV ratio is simply the loan amount divided by the property’s appraised value. For instance, if you’re borrowing $150,000 to buy a home with an appraised value of $200,000, the loan-to-value ratio is 75 percent (your $150,000 loan divided by the $200,000 appraised value).
The more cash you put down, the lower your loan-to-value ratio and, from a lender’s perspective, the lower the odds that you’ll default on your loan. It stands to reason that you’re less likely to default on a mortgage if you have a lot of money invested in your property.
Conversely, the higher the LTV ratio, the greater a lender’s risk if problems arise later with your loan. That’s why most lenders charge higher interest rates and loan fees or require private mortgage insurance (see Chapter 4) whenever the amount borrowed pushes the loan-to-value ratio (as determined by appraisal) above 80 percent.
Underwriting standards for loan-to-value ratios vary from lender to lender. A portfolio lender, for example, may feel comfortable with a higher debt-to-income ratio if your LTV ratio is low because you made a big cash down payment.
Cash reserves As a condition of making your loan, some lenders insist that you have enough cash or other liquid assets, such as bonds, to provide a two- or three-month reserve to cover all your living expenses in the event of an emergency. Other lenders reduce their cash reserve requirements if you have a low debt-to-income ratio or a low LTV ratio. Some credit unions and savings and loan associations require that you have another account (checking or savings) with them to apply for a loan.
New underwriting technology The mortgage finance industry has undergone sweeping technological changes that profoundly transformed the way lenders make loans. The two big innovations have been automated underwriting and credit scores.
Automated underwriting Decades ago, the mortgage origination process used to be a torturously slow, hid- eously expensive, ridiculously redundant paper shuffle designed by the devil to drive miserable mortals stark raving mad. Not anymore.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 33
Now automated underwriting programs objectively and accurately evaluate the multitude of risk factors present in most loan applications. Although these com- puterized programs will never completely eliminate human judgment, they’ve reduced the volume of paperwork involved in the traditional underwriting process.
Reduced paperwork has cut borrower’s loan-origination costs by hundreds of dollars per mortgage. And that’s not all. Thanks to automated underwriting pro- grams, mortgages that used to require weeks or, worse, months to process and approve can be handled from start to finish in, gasp, minutes. Hence, the tremen- dous increase in the number of options at various mortgage websites.
Increasing use of credit scores According to information provided by Freddie Mac (the Federal Home Loan Mortgage Corporation), credit scores developed by analyzing borrowers’ credit histories served as a bridge between traditional underwriting and automated underwriting systems. However, studies conducted by Freddie Mac have proven that credit scores are excellent predictors of mortgage-loan performance. As we discuss in Chapter 3, most lenders use them.
Credit scores are calculated in a neutral manner and have nothing to do with a borrower’s age, race, color, gender, sexual orientation, religion, national origin, citizenship, disability, or marital status. Your credit score is determined by objectively analyzing your record of paying debts. The following factors are considered:
» Public records pertaining to credit: A search of public records in the county recorder’s office shows whether you’ve ever declared bankruptcy. It also indicates whether legal claims have ever been filed against property you own to secure payment of money owed for delinquent loans, lawsuits, or judgments.
» Outstanding balances against available credit limits: What is the balance due on mortgages and consumer installment debt such as car loans, charge accounts, and credit cards? Outstanding balances that exceed 80 percent of your available credit limits put you in the category of a higher-risk borrower.
» The age of delinquent accounts: Another indicator of higher risk is whether you have been or are currently 60 or more days delinquent on your credit card or charge account debt or other loan payments.
» Recent inquiries generated by a borrower seeking credit: Having four or more applicant-generated credit inquiries in the past year indicates that you may need a slew of new loans or credit cards because you’ve maxed out your current ones. From a lender’s perspective, that’s an alarming development.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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34 PART 1 Getting Started with Mortgages
The credit scoring methodology most lenders use today was developed by Fair Isaac Corporation and is called a FICO score. FICO scores range from a low of 300 to a maximum of 850. If you’re just itching to discover much, much more about credit scoring, Chapter 3 can scratch that itch.
Freddie Mac analyzed a broad sampling of 25,000 loans made by the Federal Housing Administration (FHA). It found that borrowers with FICO scores of 680 or more are highly unlikely to default on their mortgages. These creditworthy borrowers are rewarded with lower loan-origination fees and mortgage interest rates. Conversely, a FICO score of 620 or less is a strong indication that a bor- rower’s credit reputation isn’t acceptable. As a result, borrowers with low FICO scores are charged higher loan-origination fees and mortgage interest rates to compensate for their loans’ higher risk of default.
Risk and the lender’s required return are always related. Seek ways to demon- strate that you’re a better risk and you can likely get lower interest rates and better terms for your loan.
Eyeing Predicament-Solving Strategies If you need proof positive that perfection is an admirable but ultimately unattain- able quality, let a lender investigate your creditworthiness. Your financial flaws will be exposed to harsh scrutiny like a mess of worms wiggling when a rock is first turned over.
Mighty few folks have flawless credit and unlimited cash. Run-of-the-mill ordi- nary mortals have a plethora of extremely human imperfections. Most individuals need a bit of assistance to surmount their shortcomings. The following sections are chock-full of suggestions you can use to solve the most common mortgage problems.
Insufficient cash for a down payment When subprime lending was at its height, getting 100 percent financing for home purchases was easy. Not anymore. Now most loan programs insist that you have “skin in the game.” That’s their catchy way of saying you must put some of your own money into the transaction. Even if you make only a modest 5 or 10 percent cash down payment, they figure you’ll be less likely to walk away from the loan because you also have money at stake. There are a few exceptions though; the Veterans Affairs and USDA Rural Development loan programs both allow for $0 down.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 35
Some things, like the exquisite hue of your baby blue eyes, are permanent and can’t be changed no matter what you do. Fortunately, a shortage of legal tender (that’s cold, hard cash for the less sophisticated) can be nothing more than a temporary inconvenience if you’re sufficiently resourceful, motivated, and disciplined.
Plenty of people have respectable incomes. For one reason or another, many of them haven’t been able to sock away much money in the form of cash savings or other readily liquid assets. If you’re income rich and cash poor, here’s a herd of cash cows mooing to be milked:
» You: Put yourself on a budget by eliminating life’s little excesses. Rent a DVD for a couple of bucks instead of forking over the better part of $20 to gaze at a first-run flick while munching on pricey popcorn. Don’t buy so many fancy designer outfits. Skip that expensive ski vacation, and check out the local museums instead. Avoid overpriced foofoo coffee, take a lunch to work, and eat dinner at home. Stifle the urge to be the first one on your block to own the latest electronic gadget. Stop smoking. Squirrel away all the money you don’t waste on frivolities. You’ll be astonished to see how quickly your savings grow.
» GI financing: Contrary to what you may think, GI financing isn’t restricted to veterans. The GI we’re referring to here is known as generous in-laws. Some parents help their children, married or not, purchase property by giving their kids cash for a down payment. Assuming that your parents have owned their home a long time, it’s probably worth considerably more today than it was when they bought it way back when. If they get a loan on their house to obtain cash that they give you, their increased indebtedness doesn’t affect your borrowing power.
Under current tax law, a parent, friend, or mysterious stranger, for that matter, can give you, your spouse, and each of your kids tax-free gifts of up to $14,000 per calendar year. For example, suppose that you’re happily married, have three adorable kids, and have truly generous in-laws. To help you buy your dream home, your munificent mother-in-law bestows a $70,000 gift ($14,000 per family member) upon the family. Ditto your fabulous father-in- law, for a total gift of $140,000 from your in-laws. (And if this gifting happens near the end of the year, they could each give you a gift in December and another in January, which would increase the total to a truly grand $280,000. Now aren’t you sorry about all those dreadful things you said about them?)
» Your employer: If you’re relocating at the request of your employer, find out whether your company will pay some or all of your down payment and other home purchase costs as an employee benefit. It’s a deductible business expense for your employer.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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36 PART 1 Getting Started with Mortgages
» Tax refund: Don’t fritter away next year’s federal or state income tax refund on baubles like a second yacht or that spiffy new Rolls Royce. Apply it to your down payment.
» Life insurance: If you have a whole-life policy, check to see how much cash value you’ve built up. Replace the whole-life policy with more modestly priced term life insurance to maintain your insurance coverage (or go without life coverage if you have no one dependent upon you financially) and free up the cash value to use for a down payment.
» Bonus: What better way to invest that huge year-end bonus the boss promised? » Income tax withholding allowance: If you’re a salaried employee and you’ve
gotten hefty tax refunds in the past, try increasing the number of dependents on your IRS W-4 form. (Complete the worksheet to see whether it makes sense.) Doing so will reduce the amount of tax that’s withheld from your check (so you don’t have to wait to get it back from the government). Put the extra money toward your down payment.
» Retirement plans: The law now allows you, if you’re a first-time homebuyer, to withdraw up to $10,000 from your IRAs if you use the money to acquire your principal residence. (Married couples can each withdraw up to $10,000 from their own IRAs.) To avoid a 10-percent penalty tax for an early with- drawal (withdrawals before you reach age 59½), you must be a first-time buyer who hasn’t owned a home for at least two years prior to the acquisition of your new primary residence. The funds must be used within 120 days of withdrawal to purchase or build your home. Many 401(k) plans also permit borrowing for a home down payment. Check with your employer’s benefits office or your tax advisor.
» Real estate: If you own a vacation home or rental real estate that has appreciated in value, you can probably pull cash out of the property by refinancing the existing mortgage.
Loans are a two-edged sword. Any loan that increases your overall indebted- ness reduces your borrowing power accordingly. This is true whether the loan in question is an unsecured personal loan from a friend or your credit union, is secured by a mortgage on real estate, or is secured by personal property such as a car, boat, or jewelry.
» Equity sharing: This technique allows two or more people to buy a house that one or more of them occupies as a primary residence. For example, a nonoccupant investor pays the down payment and closing costs in return for a 25 percent interest in the property. You, as the occupant/co-owner, get a 75 percent ownership stake for making the monthly mortgage payments as well as paying the property tax, the homeowners insurance premium, and all other maintenance expenses. Any increase in value is split according to the terms of the equity-sharing agreement either after a specified period of time, such as five years, or when the property is sold.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 37
Although unrelated people can use equity sharing, it works best between parents and their children. Given a well-crafted written agreement, equity sharing is an ideal win-win situation. Your parents get tax benefits and share in the house’s appreciation while helping you buy a home. You get a home of your own with little or no cash down, you enjoy tax deductions for your specified percentage of the mortgage interest and property tax payments, and you also share in the home’s appreciation. For more detailed information about drawing up a legally binding equity sharing agreement, consult a qualified real estate lawyer.
» State or federal programs for first-time buyers: Freddie Mac, Fannie Mae, the FHA, and many states have financial aid programs designed to assist low- or moderate-income buyers in purchasing their first home with little money down (see Chapter 4). Again, you may find that these programs define “first-time buyer” as someone who has not owned a home for just the past few years.
» Seller (owner-carry) financing: This technique may make it possible to purchase real estate with relatively little cash, because the seller takes some of the sale price in the form of a loan. For instance, you put 10 percent of the cash down, the owner carries back a 10 percent second mortgage, and you get an 80 percent first mortgage from a conventional lending institution (see Chapter 6 for more about seller financing used with 80-10-10 financing).
The number of owners willing to carry financing ebbs and flows like the tide. When conventional mortgage interest rates are high, many sellers offer lower-interest-rate second mortgages to help sell their houses. However, even when conventional mortgage rates are cheap, a few sellers do owner-carry financing for tax purposes (by spreading their taxable gain over multiple years) or because owner-carry financing has an attractive interest rate compared to returns they could get on other investments.
» Private mortgage insurance (PMI): Thanks to the availability of PMI, conventional lenders offer special loan programs for cash-poor buyers with strong incomes. If your down payment is less than 20 percent of the purchase price, you’ll have to buy private mortgage insurance to protect the lender in case you go belly up and the lender has to foreclose. Getting PMI may increase your loan origination fee and will increase your monthly loan payment. However, without PMI, you couldn’t buy with such a low down payment.
» Stock or stock options: Selling stock or stock options is a quick way to get your down payment. Before you do so, be sure you understand the tax consequences and make provisions to cover the state and federal capital gains taxes generated by the sale.
» Sale of other assets: What better time to convert your collection of rare stamps, gold coins, vintage baseball cards, agglomeration of Beanie Babies,
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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38 PART 1 Getting Started with Mortgages
first-edition comic books, or whatever else is collecting dust into cold, hard, down-payment cash?
» Lottery tickets: Hey. Somebody always wins the lottery sooner or later. It may as well be you. Stranger things have happened. Your luck is bound to change eventually. You have our permission to squander up to a buck a week. If, however, you crave a slightly more certain way to obtain cash for a down payment, we urge you to review our previous 15 suggestions.
Excessive indebtedness Death is nature’s Draconian way of telling us to slow down. Having your mortgage application rejected because you’re in hock up to your hip-huggers is the lender’s gentle suggestion that you’d be wise to put your financial house in order.
Even if you’re only moderately overextended, the lender has done you a tremen- dous favor by turning you down. If your debt-to-income ratio is too high before buying a house, piling on additional debt in the form of mortgage payments and homeownership expenses will probably turn your dream home into a fiscal nightmare.
Face it. Even though you’re perfectly willing to shoulder the additional financial burden of homeownership, the lender is telling you that too much debt will ravage your ability to live within your means. You won’t own the house; the house will own you.
Here are four ways to handle this problem:
» Reduce long-term indebtedness. If you’re close to being able to qualify for a mortgage, paying off a chunk of installment-type debt such as a student loan or car loan will most likely bring your debt-to-income ratio within acceptable limits. Discuss this game plan with your lender. (Car loans and other long-term installment debt with ten or fewer payments remaining are typically not considered long-term debt.)
Fannie Mae and Freddie Mac don’t like total monthly payments on long-term indebtedness (including your mortgage) to exceed about 40 to 45 percent or so of your gross monthly income.
» Expand income or restrict living expenses. If you’re living way beyond your means, you have two choices: Increase your income or, more realistically, put yourself on a stringent financial diet to reduce your blimpish budget. For help with this, read Chapter 1 (if you haven’t already). It helps you identify areas where you can make budget cuts.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 39
» Get real. If you have champagne tastes and an unalterable beer budget, something’s gotta give. Ask your lender to define the outer limits of your realistic purchasing power. The easiest way to cut your payments for a mortgage, property taxes, homeowners insurance, and other ownership expenses is to buy a less expensive home.
» Reach out and touch someone. If you’re lucky enough to have fiscally powerful parents or relatives to whom you can turn for financial assistance, you have a huge advantage. Consider using it. Don’t let false pride about asking them for a loan or having them cosign a mortgage prevent you from owning a home. After all, in many areas of the country, property is much more expensive today than it was back in the Stone Age when your mom and dad bought their first home.
Cosigning a mortgage is inherently risky for the co-borrowers. If you make pay- ments late or, worse, default on your loan, you sully your cosigners’ credit record every bit as much as your own. Even if you mail in your monthly loan payments long before they’re due, however, the cosigners’ borrowing power is reduced, because they have a contingent liability to repay your loan if you default. In fair- ness, you should discuss these financial ramifications with your co-borrowers before they cosign your loan papers.
Insufficient income Even if you have plenty of cash for a down payment and no debt whatsoever, you may still experience the despair of rejection. Lenders frequently turn down loan applicants if they believe the financial burdens of homeownership will be too great. As is the case with excessive indebtedness, the lenders are trying to protect you from yourself as well as protect their own interests.
Before you throw a stink bomb in the lender’s lobby, please read the section in Chapter 1 about determining how much home you can realistically afford. For example, suppose you currently aren’t earning much, because the business you started last year is gushing buckets of red ink. Under the circumstances, it would probably be prudent to wait another year or two to prove conclusively to the lender — and yourself — that your business is capable of producing profits.
If (after reviewing Chapter 1) you still believe that the lender is being too pater- nalistic, take a look at these two suggestions that may help get your loan approved:
» Increase your down payment. If you’re cash rich and income poor, make an even larger down payment. The more money you have in the property, the lower the lender’s risk that you’ll default on your mortgage.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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40 PART 1 Getting Started with Mortgages
» Get a borrower. Excessive indebtedness isn’t the only problem a borrower can cure. This may be the perfect time to ask your parents, your rich uncle Dennis, or your buddy who just won the Publisher’s Clearinghouse Sweepstakes to help you.
Credit blemishes “You can run, but you can’t hide” aptly describes the futility of trying to duck creditors. If you have pecuniary problems with the butcher, the baker, or the can- dlestick maker, woe be it to you if you’re ever slow and sloppy when paying your bills. Creditors have a nasty way of getting even with you. They report your delin- quencies and defaults to credit bureaus. These fiscal zits deface your record for years to come whenever anyone obtains a copy of your credit report.
If your credit history is a smidgen less than sparkling, one key element to getting your loan approved is immediate, detailed disclosure of any unfavorable informa- tion. Don’t play games. Give the lender a complete, written explanation of all prior credit problems when you submit the loan application. Financial dings tied to one-time predicaments such as serious illness or job loss that you’ve satisfacto- rily surmounted are usually relatively easy to handle. Also, some credit card lenders, particularly ones that are part of a retail establishment (for example, department stores), may change what they report to the bureaus as a matter of “customer convenience.” Macy’s does not want you mad at them, so ask their credit department if it will modify what it reports for your account.
It pays to take the initiative if you have trouble obtaining a mortgage. Ask your loan officer to list all the derogatory items you must rectify to get loan approval. Instead of wasting your valuable time trying to guess what’s wrong, you’ll have a nice, neat (hopefully short) checklist of everything you must correct.
Here are four ways to conquer crummy credit:
» Seek sympathetic lenders. Lenders start with mostly the same underwriting guidelines for conventional loans. But many lenders add additional restric- tions called lender overlays that make qualifying more stringent. For instance, at the time of this writing, FHA allows credit scores down to 580, but many lenders will not make FHA loans below 600–620. You may have to figure out if you are running up against the actual underwriting guidelines or a lender overlay. The only way to find out is to ask a few different lenders. When you interview lenders, don’t be coy. Ask them whether your credit blemishes present a problem.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 41
Depending on the magnitude of your mess, you may want to secure the services of a mortgage broker. Because they often assist people with credit problems, mortgage brokers already know which lenders will be most understanding about this kind of fiscal frailty. Mortgage brokers are typically approved with a number of lenders — and thus have more options in placing a mortgage.
» Seek seller financing. As we note in Chapter 5, tax advantages and high rates of return induce some sellers to offer financing for the buyers of their properties. Sellers can be more flexible when dealing with credit blemishes than conventional lenders, because they aren’t hampered by so many rules and regulations. If you’re financially strong today, a seller may be willing to overlook your past credit problems.
» Seek a co-borrower. Once again, we suggest trying to obtain the cooperation of the ever-popular co-borrower.
» Seek savings and spruce up your credit. If the lenders you’ve talked to either summarily reject your loan application or offer you outrageous loans with stratospherically high interest rates and fees, why rush to buy a home? Instead, continue renting. Concentrate on two goals — saving money for your down payment and keeping your credit record spotless. After a couple of years, lenders will be knocking at your door day and night beseeching you to honor them with your business.
Don’t waste your time working with a company that says it can quickly repair your credit. You may be told that, for a fee, your legitimate credit problems will be removed from your credit report. Sound too good to be true? It is. See Chapter 3 for honest ways that you can improve your credit reputation.
Low appraisals Did you hear the joke about the conscientious fellow who dutifully visited his friendly neighborhood dentist for a semi-annual checkup and teeth cleaning? After completing her usual meticulous, 15-minute inspection, the dentist advised our hero that his teeth passed the exam with flying colors. Then she solemnly announced that the poor guy’s gums had to go. Ta da boom!
Believe it or not, this hilarious digression (all right, mildly hilarious) does have a point. Suppose you’re a lender’s dream borrower, the embodiment of perfection — plenty of cash for a down payment, no indebtedness whatsoever, incredible income, exceptional job security, and nary a spot of derogatory information anywhere in your credit history. How could you, a Champion of Creditworthiness, ever be turned down for a mortgage?
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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42 PART 1 Getting Started with Mortgages
THE BEST DEFENSE IS A GREAT OFFENSE In the American legal system, you’re innocent until proven guilty. In the Alice in Wonderland financial realm, conversely, you’re guilty until credit reporting agencies say that you’re innocent.
Credit agencies and the creditors who report information to them sometimes make mistakes. Most folks don’t discover these errors until they’re turned down for a loan.
If that hideous fate befalls you, begin the correction process by finding the inaccuracy. For instance, if the error pertains to a charge account that’s not yours, tell the credit bureau to remove the derogatory data and put it on the correct person’s credit report.
Now suppose that it’s your account. A creditor of yours told the credit agency that you never paid a bill when, in fact, you actually paid it in full long ago. In that case, you must go back to the source of the erroneous information and have the creditor instruct the credit bureau to correct the misinformation.
Fixing this type of error requires persistence and patience. Credit bureaus, by law, must respond to your inquiry within 30 days. If you get the brush-off from frontline customer service representatives, demand to speak to their manager. If that doesn’t work, file a complaint with local government regulatory agencies.
Your best strategy is to have the blemish removed from your credit record. If the quar- relsome creditor refuses to rectify the inaccuracy, you’re allowed to enter a statement of contention in your file so future creditors who obtain your credit report can read your side of the story.
Obtain a copy of your credit report to ensure that the information is accurate. If you’re applying for a mortgage, ask for a copy of your credit report. After all, you’re paying for it.
Once per year, you can obtain a free copy of your credit report directly from each of the credit bureaus that publish them. Equifax (800-685-1111, www.equifax.com), Experian (888-397-3742, www.experian.com), and TransUnion (800-916-8800, www.transunion. com) provide credit reports. So, if you want to keep a close watch on your credit reports, you can rotate, every four months, which credit bureau from which you obtain a free copy. Also know that Section 615(a) of the Fair Credit Reporting Act is a federal law that gives you the right to receive a free copy of your credit report from the credit bureau if you ask within 60 days of being turned down for a loan.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 43
Simple. Blame the lender’s appraiser, who is of the firmly held opinion that the house you’re so madly infatuated with isn’t worth what you so foolishly agreed to pay for it. Don’t take it personally. The rejection has nothing to do with you as a fine, upstanding individual.
Low appraisals aren’t restricted to transactions involving home purchases; they’ve sabotaged their fair share of refinances, too.
Maybe the appraiser is absolutely correct — maybe not. What you do next depends on which of the following six factors provoked the low appraisal:
» You overpaid. Hey, it happens. Appraisals rarely come in under the purchase price. You and your real estate agent may be suffering from a case of excessive enthusiasm regarding your dream home’s fair market value. For example, just because you’re willing to pay $250,000 for it doesn’t mean that anyone else in the whole wide world would pay a penny over $235,000. Or the appraised value may be low because the house needs a new foundation, a new roof, and other expensive repairs that you didn’t factor into your offering price. In either case, be grateful the appraiser warned you before you made a costly mistake.
You obviously like the house or you wouldn’t have offered to buy it. If, despite the low appraisal, you still want the property, don’t give up. Get your real estate agent to use the appraisal as a negotiating device to reduce the purchase price or to get an offsetting credit for the necessary corrective work. Your home inspection report can be very helpful in identifying repairs that the seller should correct at his expense. Be sure to ask that the appraiser reconsider the valuation if it was reduced due to deferred maintenance or needed repairs that have subsequently been completed properly.
The seller is stuck with the property. You aren’t. If the seller won’t listen to reason, don’t waste more of your valuable time. Instead, move on to find your true dream home. Speaking of moving on, getting another real estate agent may also be wise if you suspect that your present agent is inept or wants you to pay more than the house is worth to fatten his own commission check. A good agent’s negotiating skills and knowledge of property values can save you thousands of dollars. An incompetent or unethical agent can cost you just as many thousands of dollars.
» The home you want to buy is located in a declining market. For several years starting in the late 2000s, lenders imposed loan restrictions on markets they consider risky because home prices in those areas were dropping. Although no longer the case in most areas of the country, a high-risk area could be as small as a specific zip code or as large as giant chunks of California and Florida. If your dream house is located in a declining market area, you’ll have to put more cash down and pay higher interest rates and loan fees to offset the lender’s increased risk due to actual or perceived falling property values.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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44 PART 1 Getting Started with Mortgages
Stigmatizing every single property in a zip code or, worse yet, a major metropolitan area as risky is a sledgehammer solution to the problem. Local neighborhood conditions can and do vary widely within a zip code or city. Lenders may make an exception to the dreaded declining market designation if your appraisal demonstrates conclusively that property values aren’t falling within the specific geographic area where your dream house is located.
» Prices dropped since you bought your home. This predicament periodically clobbers folks trying to refinance a loan. Real estate is an excellent long-term investment. However, like the stock market, the real estate market has short-term boom-and-bust cycles. For instance, suppose you paid a record high price several years ago when you acquired your home at the pinnacle of a strong (seller’s) market. In our hypothetical situation, assume that the country is now mired in a deep recession, and houses like yours are selling for far less money. If that actually happens to you, don’t kill the messenger for accurately reporting current property values. (Take this as an opportunity to buy an investment property or at least ask your local tax assessor to lower your assessed value and save money on your property taxes.)
Property prices aren’t fixed. They slither all over the place. A house’s fair market value (FMV) is based on what buyers offer and sellers accept. It’s not a specific number — it’s a price range. To push your appraisal toward the high end of FMV, have your real estate agent give the appraiser a list of houses comparable to yours in location, condition, size, and age that sold within the past six months. Unlike good real estate agents, appraisers generally don’t inspect every property on the market. If your agent toured all these houses and the appraiser didn’t have time to see some of them, your agent should review the properties with the appraiser to help the appraiser understand why the highest sales are the best comparables.
» The appraiser doesn’t know property values in your area. Suppose that, while looking for your dream home, you and your agent saw five comparable houses (near the home you want to buy) that completely justify the price you agreed to pay. If the appraisal comes in low under these circumstances, the appraiser may not know neighborhood property values.
When you suspect that the appraiser is geographically clueless, get a copy of the appraisal from the lender. Check the houses the appraiser selected to establish fair market value to see whether they’re actually valid comparables for the home you want to buy. If they aren’t, discuss your concerns with the lender. Find out how many appraisals the appraiser has done recently in the neighborhood. If the appraiser doesn’t work in the immediate vicinity, the appraiser’s opinions of value are suspect. In this situation, some lenders will have the property reappraised without charging you.
» The appraiser did not properly value your specific property. Maybe some- thing unique about the property you’re buying justifies the higher valuation.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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CHAPTER 2 Qualifying for a Mortgage 45
Although an appraiser should take into account all the differences between the comparable properties and your dream home, the dollar value of the adjust- ments to the valuation are subjective. If your property has a killer view and most of the comparable properties overlook a nearby power plant, the appraiser may not have properly accounted for this superior feature of your future home.
The appraiser may not always acknowledge the size of the parcel as well as other unique features, so look at the appraisal report narrative and see whether he considered these positive benefits when reaching his final opinion of value. Yes, it’s just his professional “opinion” of value and you may be able to point out inconsistencies, or some lenders may even allow you to get a second opinion in the form of another appraisal.
» The lender is redlining. Redlining is the discriminatory act of refusing to make loans in specific neighborhoods that a lender considers undesirable. Because this practice is illegal, it’s the least likely explanation for a low appraisal from a reputable lender.
Request a copy of your appraisal if you suspect redlining. After carefully reviewing the comparable sales data to establish that the appraisal is unrealistically low based on your firsthand knowledge of comps, ask the lender to explain why. If you’re not satisfied with the explanation or if you get the runaround, ask for a full refund of your loan application and appraisal fees; then take your business to another lender. You may also consider filing a complaint with the appropriate agency in your state that regulates mortgage lenders.
Problem properties Two types of residential property — cooperative apartments and fixer-uppers — are difficult to get mortgages on. The intricacies of these properties are discussed in great detail in Home Buying For Dummies (Wiley). This section simply highlights the financing problems associated with these types of properties.
Cooperative apartments When you buy a house or a condominium apartment, you get a deed that proves you have legal title to the property. Nice and simple, isn’t it?
When you buy a cooperative apartment, usually called a co-op, you get a stock cer- tificate, which proves that you own a certain number of shares of stock in the cooperative corporation. You also get a proprietary lease, which entitles you to occupy the apartment you bought. The cooperative corporation that owns the building has the deed in its name. Confusing, isn’t it?
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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46 PART 1 Getting Started with Mortgages
In places such as New York City and San Francisco, where co-ops are common, mortgage financing on this type of property is readily available. In many other parts of this great land, however, lenders find co-ops legally daunting. They don’t make co-op loans, because they refuse to accept shares of stock in a cooperative corporation as security for a mortgage. Compounding the problem, some co-ops won’t permit any individual financing over and above the mortgage that the coop- erative corporation has on the building as a whole.
If only one or two lenders in your area make co-op loans, don’t buy a cooperative apartment unless you’re independently wealthy. You’ll likely end up paying a higher mortgage interest rate due to limited competition and the lenders’ con- cerns about the risks involved with co-op financing. Worse, what happens to you if these lenders stop making co-op mortgages and no other lenders take their place? You won’t be able to sell your unit unless you find an all-cash buyer (rare birds, indeed) or you decide to carry the loan for the next buyer.
Fixer-uppers Fixer-uppers are properties that need work to put them in pristine condition. If the house you want to buy needs only cosmetic renovations (painting, carpeting, landscaping, and the like), you probably won’t have a big problem obtaining a mortgage.
However, suppose the apple of your eye is a house that needs serious structural repairs, such as a new foundation, a new roof, and the installation of new electri- cal and plumbing systems. We have to question the wisdom of buying such a needy property. Don’t say we didn’t warn you. If your dream house is a corrective-work nightmare, getting financing may be tough unless you use spe- cific renovation loans such as the FHA 203K, Fannie Mae HomeStyles, or Freddie Mac Renovation Program. These loan programs finance both the acquisition and needed repairs.
Of particular concern is the reliability of the roof. If the appraiser sees evidence of water damage, like water stains on the ceiling, he will mention it, and you will probably have to provide a roof certification after examination by a roofing com- pany. The lender may not allow closing until the roof is repaired.
A good real estate agent should know which lenders in your area specialize in renovation loans.
Griswold, R. S., Tyson, E., & Tyson, E. (2017). Mortgage management for dummies. Retrieved from http://ebookcentral.proquest.com Created from apus on 2020-05-21 07:57:49.
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