It is a familiar scenario. A homeowner is thinking of refinancing their mortgage or even buying a new house. You may even feel a bit entitled since you know you have good credit. Slam dunk baby is what you are thinking!
But then you get denied. Confusion reigns. What the hell, you say to yourself! Then a friend of yours tell you that he read where the average credit score for loans recently denied is over 720.
Hmmmm…..now you are really at a loss for words.
Mortgages are unlike any type of credit application a consumer encounters. Everything is backwards. An applicant may feel that they are attempting to “qualify” for a loan. Ironically, that perspective could not be further from the truth.
Let me try to explain without using any words that typically make one’s eyes glaze over.
Applying for a mortgage is akin to baking a cake but, instead of for you or a loved one, the work is for the bank. Your income, credit, liquid assets, debts, how much money you can put down or equity, and the appraised value of the home are all layers in the cake.
I already hear the comment: Why can’t I just get a damn loan?
Nope, it is impossible to just wing it. Complexity reigns in the 21st century. The housing market crashed because of all the cakes that were made for banks in mid-2000’s that looked good, but in reality the layers were all out of balance.
Today, we are on the opposite end of the spectrum. The layers of the cake and icing now must be perfect. It is no longer acceptable for everything to line up and the icing to taste good. No, banks must sell the best finished product possible to Wall Street or Fannie Mae or Freddie Mac. Everything is about risk avoidance, be it lawsuits, having to buy back the loan, and possible civil or even criminal penalties.
If you are willing, I can help you begin thinking like a bank. The next time you refinance or buy a home, you will be well positioned to create the best cake possible and help your lender help you.
Mortgage ask their clients for all kinds of documents, but rarely do they explain the reasons behind the requests. That has to end. Here is a beginning explanation of each layer of the cake:
Credit: Your credit score is supposed to show your ability to handle debts and repay loans. Right now that bar is set very high so the number of loans approved remain low. Your score right now should be 730 or higher. And you can’t always go by free credit services. Mortgage credit is viewed as the most risky. So when your lender pulls your credit, it could well be lower.
Income: The important feature of this layer is to show consistency and hopefully increases. Declining gross income is a major warning sign regardless of your credit. It is never a bad idea to average or blend your income over two or more years even if you are a W-2 employee. Unless of course you are a commissioned employee, self-employed or own more than 25% of a business. Then you must average your gross income, follow a formula that involves two full years of your entire tax returns, profit and loss statements, and of course an independent certification from your accountant.
Employment: The type of job you have carries its own set of risks. While one can argue that any job is potentially risky in this day and age, a general rule of thumb is W-2 employees carry less risk than say a self-employed or a commissioned employee. Also, even if you are paid on a salary basis, but own more than 25% of the company, you will be classified as self-employed.
Liquid Assets: For the purpose of this blog, liquid assets will be broken down into two categories. Checking and savings accounts can be used in total. Generally, two months of your most recent statements are required. Everything else — stocks, CD’s, retirement accounts, and inheritance– should all be calculated at 75% of their current value. The more liquid assets you have only strengthens a loan applications. FYI, your house is not counted as a liquid asset.
Marital status: This is a tough one. You have been divorced for years and you do not even give this another thought. Think again. Everything from alimony to child support to loan repayments must be evidenced. Have a copy of your final divorce decree and separation agreement handy.
Loan type: Government-backed loans (FHA), those purchased by Fannie and Freddie, and home equity loans or lines of credit all carry different types of underwriting risks and appraisal rules. For instance, a home equity line of credit used to buy a home is easier to combine into a first loan than one started after you moved in to your new house. Likewise, an appraisal for an FHA loan that notes problems with the house, well, and septic system must be fixed prior to a loan closing.
Escrow payments: Banks prefer that you escrow your homeowners insurance and property taxes, pure and simple. The risk of an insurance or tax foreclosure must be avoided at all costs.
Property type: Single family residences, PUD’s, condo’s, and cooperatives all have varying degree of risks. Without getting too involved for now, I advise you to tell your loan officer exactly the type of property you live in. It is always not clear cut.
Appraised Value: I view the appraisal as the icing on the cake. Everything else can be perfect but if the property does not appraise, you are out of luck. Even for those loans that allow homeowners who owe more than the worth of their homes have limits.
As crazy as it sounds, the above points are the basics. Meanwhile, the rules are constantly changing. The only part that remains the same is the residential loan application as it is a government document.
Mortgage bankers need to do a better job explaining their craft. Remember, homeowners apply for a mortgage only a handful of times over the course of their lifetime and are at a bit of a disadvantage. Loan officers have an awesome responsibility to go beyond merely taking an application.
My goal will always be to keep informing and teaching my readers. So in the end, you have a perfect cake instead of the grumpy looking person at the top of this blog! Cheers!