Occasionally, I think that I have covered every imaginable real estate related topic. After 8 years of writing this newsletter, I seem to have reached that point. So, what does one do under the circumstances? One possibility, of course, is to update previous topics. Rewriting and re-editing to enhance clarity and flow are other worthwhile goals. Hence, what I am about to embark here is version 2.0 of MST's Talking Points. As the vast majority of readers were not with me at the inception of the newsletter, like the old joke, if you've never heard it before it's new to you. So, I believe that by covering anew some of the more prosaic topics, there's worth for new readers while reinforcing an understanding of the mortgage process for the veteran readers. Because the lending universe is ever-changing, updating previous material has obvious merit. Since I had already planned to run a piece for this issue titled "Why Mortgages Are Denied as Never Before", I thought where better to start than with its necessary antecedent qualifying.
It's been said that the three most important things in real estate are location, location, location. Whether you are a first-time homebuyer or refinancing for the nth time, for a borrower the three most important steps in obtaining a loan are Qualifying, Approval and Funding. In one sense, it's Qualifying, Qualifying, and Qualifying because if you don't qualify, you'll never reach the other two. Because we are a full-service lender (offering both conventional loans and hard money loans) I've only occasionally found this to be a problem for my clients.
When it comes to qualifying, the triumvirate that underwriters focus on is credit, assets and income. Obviously, if a lender is going to extend credit to a borrower, it wants the loan to be repaid. One of the best ways to determine whether a borrower is worthy of granting credit is to look at their credit history. Your credit report is essentially a PERMANENT RECORD of your borrowing history and your FICO score is partially based on it. The FICO scoring process is a computation derived from an algorithmic formula for credit risk assessment that was devised by the FAIR ISAAC COMPANY. It is used by lenders because it is highly predictive of future payment risk. It was not (as most people mistakenly believe) designed to measure your credit worthiness, instead it is a mathematical model specifically designed TO PREDICT THE LIKELIHOOD THAT A BORROWER WILL HAVE A 90-DAY LATE PAYMENT WITHIN THE NEXT 24 MONTHS ON ANY CREDIT ACCOUNT and for this reason it's not as intuitive as one might surmise.
Not so long ago it was possible to obtain a loan if your FICO (credit) score was over 500. But lenders have tightened their guidelines in recent years. Today, that number is 620. Borrowers with a 620 FICO are in the lowest quintile of the general population (or bottom 20 percent) and as such they are viewed as risky or "C" grade borrowers. Below 620, you will qualify for little other than a hard money loan, though there are a few sub prime lenders that will go down to a 580. The current threshold for FHAs and VAs also is a minimum of 620, although most lenders have raised the qualifying score to 640. The Web site myFICO.com reports the breakdown of the general population's FICO scores as:
*20 percent below 620
*20 percent between 620 and 690
*20 percent between 690 and 745
*20 percent between 745 and 780
*20 percent above 780
The second area that underwriters pore over is ASSETS. The more you have of these the more secure an underwriter feels about a file. Good credit is an indication of your aptitude to repay a loan. Income is an indication of your ability to repay it and assets are reserves that may be tapped in the event that something interrupts your income, like a lay-off, an accident or illness. If you have ample assets you can usually weather a business reversal or minor health issue.
One's INCOME is the area that warrants the most scrutiny because it determines one's ability to service the debt and how much of a loan one can reasonably afford. To assess this, underwriters look at one's gross monthly income and they use this number to calculate a borrower's Debt-To-Income ratios or DTIs.
Now is as good a time as any to discuss ratios. What conventional lenders consider ideal are ratios of 28% on the Front End (FE) and 36% on the Back End (BE). What this means is your HOUSING EXPENSE SHOULD NOT EXCEED 28% OF YOUR GROSS MONTHLY INCOME AND WHEN ADDED TO YOUR LONG-TERM DEBT (any account with more than 10 months of payments remaining) SHOULD NOT EXCEED 36%. Some lenders will allow HIGHER ratios like 33% and 38%. Others will go as high as 36% ON THE FRONT END (FE) RATIO AND 45% ON THE BACK END. In years gone by, sub-prime lenders would allow BE ratios as high as 50 to 55%. Regardless of what the ratios are for a particular lender, a broker can always lobby on your behalf with that lender's underwriter by presenting what are known as compensating factors. It may work, it may not. Nevertheless, here is a partial list of them:
1. No debt or little debt.
2. Excellent long term credit, including previous mortgage and/or rent payments and
high credit scores.
3. Proven ability to pay debt in excess of allowable ratios.
4. Large amount of liquid assets left after closing.
5. Proven ability to save.
6. Good potential for increase in income.
7. Long term stability.
8. Possessing an advanced degree or is working toward one.
9. Large down payment, low LTV loan.
10. Ability of nonworking co-borrower to obtain a job in which he or she has a
11. Potential for a large amount of overtime or a bonus.
12. Shorter loan term.
13. Little or no increase in housing expense.
14. Other income not used in qualifying.
Computer underwriting through proprietary software programs like Fannie Mae's Desktop Underwriting (DU) or Freddie Mac's Loan Prospector (LP) skip the human element of an underwriter and can significantly improve on even the most liberal qualifying ratios. I have seen approvals on loans with LTVs of 90% and FE ratios of 45% and BE's of 70% and LTVs of 95% with FE and a BE of 38% and 65%, respectively. THESE ARE NOT THE NORM, however.
A major sub-prime lender I spoke with said that only 19.6% of the applications they receive result in loan closings. I suggested that the low percentage might have more to do with the fact that they were a sub-prime lender. He replied, "Not really the industry average is about 1 in 5 or 20%". My success rate is over 95% because I thoroughly pre-qualify borrowers by taking a complete 1003 (Uniform Residential Loan Application) and by sending an accompanying Letter of Explanation to the underwriter as to what the borrower is attempting to accomplish. It sounds elementary, but you would be surprised at how many loan officers omit this often times critical step that results in their file being denied.
OTHER STRATEGIES FOR QUALIFYING
If you're a first-time home buyer that's a bit short of the needed down payment or the cash reserves that most lenders require borrowers to have (in the event that one loses one's job or has an accident that temporarily keeps them from working), what follows are some "thinking outside the box" strategies worth considering:
1. EMPLOYER. If you're relocating at your employer's request, your company may pay some or all of your down payment and home purchase costs as an employee benefit.
2. LIFE INSURANCE. You may be able to tap the cash value of your policy if it's a whole life or universal life policy.
3. TAX REFUND. It may be enough for your down payment or the cash reserves that a lender requires.
4. RETIREMENT PLANS. The government allows first-time home buyers to access up to $10,000 from heir IRAs and 401(k)s prior to age 59 (without a penalty for early withdrawal). So, a couple could obtain as much as $20,000 here alone.
5. GIFTS. Some parents or generous in-laws help their off-spring with their starter home by gifting them some amount toward that all too critical down payment. The current tax law permits tax-free gifts of up to $13,000 per calendar year.
6. EQUITY SHARING. This situation allows two or more people to buy a house that one or more of them occupies as a primary residence. For example, a non-occupant investor might make the down payment and closing costs in return for a specified interest in the property, while the actual occupant(s) would have a greater or lesser interest in the property in exchange for making the monthly mortgage payments, taxes, insurance and maintenance.
7. CARRY-BACK FINANCING. This situation involves having the seller carry a 10 or 20% second mortgage or some variation of this. If for example, one had only 10% for a down payment, have the seller carry back a 10% second mortgage and obtain an 80% first mortgage via a conventional lender, thereby precluding the need for an outside 2nd or HELOC (Home Equity Line Of Credit).
The three areas that underwriters primarily focus on when it comes to qualifying a borrower are income, assets and credit score. Should a borrower be deficient in one area, various strategies and/or compensating factors may yet enable them to qualify.
Copyright © 2020 Rod Haase. All rights reserved.