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As you are preparing to house hunt, get your mortgage secured through a pre-approval.
Applying for a mortgage? What matters?
There are things about you and your finances that are going to be studied, legitimately, before a lender will give you a mortgage. That makes sense; they are lending you a large sum of money.
But, there are some things that are none of their business, literally!
Who you are – in terms of race, ethnicity, marital status, whether you have children or not, your age, or whether you are a member of any protected classes.
The income or debt of someone else in your household (if he/she is not going to be on the loan). This is such a common situation for first-time borrowers, I wrote about it just last month. Because all mortgages balance income and debt, sometimes one person in a couple can get a mortgage, but the other person has too much debt or too low a credit score to also be on the mortgage. Whether the non-borrower can be on the Deed depends on whether or not you are married.
Source of your income. The key thing that lenders are looking at with your income is, “Will it continue?” Therefore, some income will not count.
What legitimately matters:
People who have a higher income at certain times of the year must be able to show a history of steady annual income. (Example: Some seasonal employees get laid off for three months every winter, but earn well through the summer.)
A common problem for young families occurs if the lender questions whether a woman will go back to work after maternity leave. If she is on leave and intends to return to work, her income should count. Show the lender that what the annual income has been, and what you expect it to be in the year of the leave.
How many lenders you check with before applying for your mortgage. Your credit score will go down when you request a credit report for any company that will give you credit. That makes sense. Having a lender look at your credit score indicates that you intend to borrow money. If you make many inquiries to borrow money, it could mean you are broke! But, the credit scorers aren’t that stupid. They know that people shop around for the best deal on a mortgage. To limit your credit score reduction to one inquiry, contact all your lenders in the same week or two.
Not all pre-approvals are created equal.
Mortgage pre-approval is an essential part of any offer. Sellers and their agents now reject offers that are not near-certain to get financing. Your true pre-approval is your best tool to prove that you are ready to buy.
Experienced agents and agents in well-run offices know that some lenders will write a “pre-approval letter” that means nothing. If you present a letter like this, you may fail to get your offer accepted.
Which pre-approvals will work against you?
- Weak pre-approval letters are written based on a phone conversation, with few or none of your financial records checked. Some companies do only that, and call it a “pre-approval.” Some companies add a credit report, which is still not enough.
- Weak pre-approval letters also come from lenders who do not do regular business in the area. If no one has heard of your lender, that is a red flag in the brokerage community.
- Weak pre-approval letters also come from lenders who are notorious for last-minute problems or last-minute mortgage failures. Any agency that faced last-minute drama or had a transaction fall apart never forgets which company caused the problem. That lender causes an immediate negative reaction whenever its name is seen on a pre-approval.
What information do you have to give to get a solid pre-approval?
Effective January 10, 2014, lenders are being told they have to be consistent and check all borrowers completely. Ability to Repay (ATR) guidelines require all borrowers to provide at least all these things:
- Credit report
- Current employment status
- Current Income and assets
- Monthly payment for the mortgage
- Monthly payments on other loans related to the property (such as a second mortgage)
- Monthly cost of other mortgage-related obligations (such as property taxes and insurance)
- Other debts such as credit cards, auto loans, student loans, child support, alimony, etc.
- Monthly debt to income or residual income after all monthly debts are paid
The Qualified Mortgage (QM) rule is designed to protect borrowers against risky loans. These meet “qualified mortgage” guidelines:
- Have a loan term of 30 years or less
- Not have negative amortization
- Not have a balloon payment
- Upfront points and fees can’t exceed 3 percent of the total loan amount on loans greater than $100,000. Other limitations apply on loans less than $100,000.
- Debt-to-income ratio may not exceed 43 percent*
*This DTI can be superseded if the loan is approved by Fannie Mae, Freddie Mac, FHA, VA, Mass Housing, USDA, or is kept in portfolio by a qualified small mortgage lender.
The lists above seem like guidelines for responsible lending. Currently, conforming conventional mortgages are allowing 45 percent or more debt-to-income (that is all debt, not just the mortgage.) Some latitude on debt to income is allowed if the borrower had a large down payment, great credit score, large reserves, etc.
What do you need to get a pre-approval that will not have problems down the road?
- A recent credit report (less than 90 days.)
- Tax returns. Especially important for self-employed, business partners, and people with unique income streams. Some of the items on your Schedule C can be added back into your income, so that your adjusted gross income more closely reflects your true income. Tax returns also find hidden liabilities which could cause your loan to fail later.
• Bank statements. The loan officer should be fully aware of the source of your down payment, funds to close, and post-closing reserves.
• Completed Automated Underwriting. Lenders have software to check if your financial information will pass the standards for Fannie Mae and Freddie Mac (national mortgage resellers). Your information should be checked against this software to assure that any problems are found early.
• Documentation about potential problems with the collateral. Once you find a property, tell your lender the vital statistics of a condo association or any factors that could come up in an appraisal. There are financial factors in a condo association that can foil your mortgage. Among these: new associations with no track record, condos where one person or company owns a large percentage of the units, condos where there are renters in the other units. Checking ahead will save you time and money. (Your lender will do a complete review of the condo documents and budgets before closing.)
Do’s and don’ts for getting your mortgage
Lenders are looking for fraud. Don’t accidentally make changes that will get your loan application scrutinized. If you are planning a move in 6-12 months, here’s what to do to help make your mortgage process go better. The paperwork does not have to be overwhelming, if you are prepared.
What to avoid – unless absolutely necessary:
• Don’t transfer funds between accounts within 30 days of applying for financing. Example: If you transfer $10,000 from a long-term savings vehicle to your checking account, you will have to document the funds leaving and arriving at each account. It can cause unnecessary confusion. Underwriters don’t like confusion.
• Don’t make large (greater than $1,000) non-payroll deposits within 30 days of applying for financing. If you have large non-payroll deposits, find out how to document them from your lender. Then, keep a good paper trail.
• Don’t sell stocks or liquidate bonds. If you need to do this, find out how to document them before doing the sale.
• Don’t apply for loans or lines of credit, especially credit cards. Don’t buy furniture or any other big-ticket item on credit. This can affect your credit score. Changes in your credit score can cause your mortgage to fail at the last minute.
• Don’t make large (greater than $1,000) financial purchases or transactions unless you do this regularly and can document them.
These things help!
• Do save and gather 30 days most recent pay stubs and bank statements. (Some lenders want 90 days.)
• Do make sure you have your most recent two years of federal income tax returns and W2s available.
• Do pay your bills in a timely fashion, especially credit cards. Missing payments is a big ding to your credit score. Beware of store credit cards; they are easy to forget about and then miss a payment.
• Do keep your credit card balances below 10% of the maximum. Even better, avoid any balances, if possible.
• Do make copies of gift checks and obtain gift letters prior to depositing funds (if gifts are necessary). The underwriter is responsible for checking that additional funds into your accounts are not loans. Additional loans create a higher risk of default, in the eyes of an underwriter.
• Do be prepared for the underwriter to request detailed follow up documentation regarding past addresses, legal agreements, etc. (For example, one of my clients was asked for her divorce agreement to confirm that she wasn’t paying child support.)
