Qualifying priorities- income, credit, downpayment
It wasn’t so long ago that we could write about how easy it was to get financing to purchase or refinance a home. Lenders were simply looking to you for the “Holy Trinity” of income, credit and reserves/assets. The good news is that Calculating income used to be so simple. If you were a salaried employee, you provided W-2s for the last two years as well as pay stubs for the last month. The loan processor would either send out a VOE (a verification of employment) or make a phone call to the payroll department and your income was verified. You then divided that annual income by 12 and you had your monthly income. If you were self-employed, you provided two years of tax returns with schedules and a current year update. The net income was averaged, divided by 12 and, voilá, you had your monthly income. The loan officer might ask you to sign an IRS form 4506 tax return request, but then it went into your file to collect dust.
INCOME
Today, the process has a different reality. For the salaried individual, the documentation remains the same, but the verification is a lot more stringent. Though you are required to supply the same paperwork, your employment will be verified independently by not only the lender’s processor but also by the closing department. Why? Lenders have found that it is too easy to create W-2s and paystubs on a computer, submit a friend’s phone number for income verification and create phantom income. It happens.
The new step is that lenders are now requiring a signed IRS form 4506 even for salaried employees. What is a 4506? It is a request for copies of your filed tax returns from the IRS. In the past they were placed in your file in case of a lender audit. Now, they are run on EVERY loan application. Not only is the lender looking for potential fraud but also for the too-common situation where the salaried individual has a side business that shows large paper losses that greatly reduces residual income.
CREDIT
We have written often about the importance of a good FICO score. Today it is more important than ever. To get the very best rates and terms, you will need a 740 credit score and a 20% downpayment. To get a conventional, Fannie Mae or Freddie Mac loan without a 20% downpayment is impossible unless you have a minimum credit score of 720. FHA allows for lower scores and lower downpayment of 3.5%.
Why? Because there isn’t a single mortgage insurance company that will insure that loan. Even if the DU/LP (Fannie and Freddie’s computer approval programs) approve your loan, MI companies will not insure it. In every case, even with excellent scores, you will have to write a letter explaining every late payment and every credit inquiry. In their due diligence, underwriters want answers. In the case of inquiries, especially current ones, the underwriter wants to be sure that you haven’t obligated yourself for new payments that haven’t appeared on the credit report. Don’t buy that new car or furniture before you purchase your home.
With 20% down, there is flexibility as to credit scores for conventional programs, but the era of low credit scores for conventional programs is gone for now. This is why FHA has become the new focus for purchasers and refinancers alike, since FHA guidelines are not credit score driven. Though FHA does not have a minimum credit score, most lenders will not originate a loan without a minimum score of 620. Choice Finance can manually underwrite anything lower down into the high 500’s if the file makes sense.
Downpayment/Reserves
Unless you are a veteran with full eligibility, there are very few 100% financing programs available. Whether you are buying a home or you are refinancing, you will need funds and you will need to document the source of these funds. Lenders will want to see a minimum of two months’ statements on all assets used for qualification and every page of each statement. And they will want an explanation, with documentation, for every large deposit that appears. Conventional loans will require a minimum of a 5% downpayment (high risk areas may require more) while FHA requires a minimum 3.5% investment. In addition, you will need extra funds for closing costs and prepaids. Beyond that, you will have to show reserves.
In the past, conventional programs required two months’ reserves, but many lenders now prefer to see six months. Retirement plans, 401ks or IRAs can be used to satisfy that requirement. However, you will only get credit for a maximum of 75% of the portfolio’s value. And when you are refinancing and not taking any cash out, conventional lenders will want to see two months of reserves even if you left 20% equity in the home.
Again, the government insured FHA/VA programs offer the best hope since their guidelines do not require reserves. © 2009, Real Estate Information Services, Capitol Assets, & Choice Finance®