“It’s impossible to get a mortgage” or “You need perfect credit” is what we often hear and read about mortgages, but that’s not necessarily the case.
“This is really kind of a false narrative. It’s complete and utter nonsense that becomes a self-fulfilling prophecy because would-be homebuyers don’t (apply) because they think they can’t get a mortgage,” says Joe Parsons, a senior loan officer with PFS Funding in Dublin, Calif.
Mortgage rules changed post-housing meltdown in 2008. For instance, in January 2013, the Consumer Financial Protection Bureau’s regulations for a Qualified Mortgage (QM) — one of the results of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) — took effect. While no one denies that getting a mortgage has become more difficult, the documentation more onerous and the process more frustrating, loans are still being made — and not just to borrowers with credit scores of 720 or higher.
How Much Can You Borrow?
Income is important, particularly for self-employed borrowers, but the ratio of income to debt is equally, or even more, crucial. Alimony, child support, car payments, student loans, credit card debt and revolving debt, as well as your monthly mortgage payment, property taxes and insurance all figure into this equation. The QM limits debt to 43 percent of income, but individual lenders might require even lower ratios. (Fannie Mae, however, raised its debt-to-income ceiling to 50 percent in 2017.)
Credit scores also play into the interest rate you receive on your home loan or how much cash the lender will ask you to put down. A lower credit score might mean a higher interest rate or a higher down payment. Although a few companies might accept lower scores for an FHA loan, many will not consider a borrower with a score below 640, observes George Acerbly, a Connecticut lender and underwriter. Still, for FHA loans — which allow a smaller down payment than traditional or “conventional” mortgages — borrowers have to have a credit score of 580 or higher.
The number of credit cards you have doesn’t matter, but how much you owe does. And quite often, whittling those balances down can bump up your credit score. “The lower the balance, the better the credit score,” says Acerbly. If you are planning on buying a house, experts advise against canceling any credit cards and say it’s best to wait to apply for any new ones until after the transaction is completed.
Expect to provide two years of tax returns and pay stubs. Self-employed borrowers need to show they have the cash flow to support the monthly payments under the QM’s ability-to-repay rule. Overtime pay and bonuses have to be documented for two years and the amount allowed is averaged over two years. “When they are looking at assets, underwriters are not just reviewing the files, but there are auditing the files,” shares Parsons.
Applicants are often surprised to find they might have to account for sources of cash in the bank, even if they are not going to use it for the down payment, explains Parsons. “The money has to be sourced and seasoned.”
According to qualifiedmortgage.org, “sourcing is basically identifying where the money came from. Seasoning means the money has been in the bank for a certain period of time,” generally 60 days or more. Gifts from relatives can be used for a down payment, although lenders also vary on how much can be applied toward the down payment. They often can be deposited directly into an escrow account and require completion of a gift letter.
Most Realtors and home sellers will want you to be preapproved before writing a contract, but the time to begin thinking about a mortgage is several months before you plan to buy. Online apps will give you some idea of what you can borrow, but experts say they don’t take into consideration nuances nor will they work to resolve any last-minute glitches. A skilled lender can troubleshoot the process and alert you to any red flags, which might include excessive overdraft fees or a spouse’s credit score. If you don’t qualify for a loan, many lenders are happy to work with you and suggest ways to improve your score so you will qualify.
Before you begin your home search, it’s important to understand the obstacles involved in obtaining a mortgage. Work with lenders to improve your standing and aid in qualifying. Keep thorough records of tax returns, pay stubs and financial gifts and minimize your debt-to-income ratio in order to lower interest rates.
Though the market is tough, it’s not impossible to obtain a mortgage. With a little research and planning, you too can soon experience the joys of homeownership.