Getting a pre-approval is the one of the first steps in the home buying process, but that alone doesn’t get you to the closing table. Knowing the rules ahead of time can help you steer clear of unnecessary pain and suffering. The world of mortgage has changed dramatically in the past few short years. At the peak of the real-estate bubble, mortgage professional joked that you needed a pulse and a social security number to get a loan. These days, even borrowers with good incomes and good credit scores can get turned down.
Much of the change is driven by the higher standards of the companies that buy mortgage loans, including Fannie Mae, Freddie Mac and large banks. Here’s what you need to look out for if you’re trying to land a mortgage, whether you’re buying a home or refinancing:
1. The house is not in good repair.
A lot of properties on the market these days are foreclosures owned by banks, and many aren’t in great repair. If a house is in really bad shape, it can be tough, if not impossible, to persuade another lender to give you the money to purchase it. Broken windows, missing fixtures, roof leaks, water damage, or lack of flooring can all cause a home not to qualify for a loan. Rehab financing is available; however those loans are tougher to get and usually come with a higher cost.
2. The appraisal came in lower than the purchase contract price.
Occasionally during the housing bubble years, an appraiser might decide a home was worth less than the purchase contract price. But that was relatively rare. Critics of appraisal standards accused appraisers of “hitting the number” — deliver the values needed for loans to be approved. Appraisers acknowledged the pressure, saying banks would turn to their competitors if they didn’t reach at least the amount on the purchase contract.
These days, new rules and big penalties hold appraisers to higher standards and sharply limit communication between appraisers and lenders. So the appraisal on the home you want to buy may fall short of the agreed-upon selling price.
Your Realtor may be able to show there are better “comparable sales” available than the ones the appraiser used. In general, though, appraisers are much harder to influence. You may need to reopen negotiations with the seller or come up with a bigger down payment to make a deal work — or pay down your mortgage in order to refinance.
3. You have too much debt.
Lenders look at how much of your income will go toward housing expenses, PITI (Principle, Interest, Taxes, and Insurance) as well as how much you spend on other debt payments.
The total amount of your income that can be eaten up by these expenses can vary by the lender and even by the day. Over a matter of months, mortgage buyers dropped the ceiling of total debt from 65% to 55% and then to 50% of gross income. If your projected housing-and-debt ratio exceeds 40% of your income, you should think twice about buying a home, not because you won’t get approved, but because you’re carrying too much debt. You should pay off all credit cards, this type of debt indicates you’re already living beyond your means, a situation that’s likely to worsen if you buy a home.
Between the time of pre-approval and finding and negotiating a house to buy, don’t incur new debt on cards or open accounts that will show on your credit report.
4. You’re self-employed and your income has declined.
To get a mortgage, you typically need to submit the past two years’ tax returns. If your 2008 income was lower than your 2007 income and you’re a W-2 wage earner, lenders will simply use the lower figure to decide how big a mortgage you can get.
The industry is far more leery of declining income if you’re self-employed. Some lenders will use the 2008 figure, but others won’t make the loan at all because they’re worried your income will drop further and you’ll default.
If you’re self-employed and your income has dropped, talk to your mortgage professional about how that might affect your loan.
5. You recently started being paid on commission.
Companies eager to cut costs have been switching some of their staffs from salaries or hourly wages to commissions. Lenders typically won’t count commission income unless you’ve been earning commissions for at least two years. If your company switched you to commissions before the end of 2008, you may have to wait to get a loan or use a spouse’s income to qualify.
6. There is a problem with your tax returns.
Lenders don’t accept your copies of your tax returns as the final word about what you earned. These days they order transcripts of the returns you filed with the Internal Revenue Service and compare those with what you had submitted.
Your loan will get tossed if you exaggerated your income, of course. But other problems include:
Unreimbursed employee expenses. Any amount taxpayers deduct for these expenses has to be deducted from the income that can be used to qualify them for a loan.
Second-home expenses. Even if you own the property free and clear, the taxes and insurance you pay on it will affect your debt ratio. Borrowers may not list the property on their initial application, especially if there’s no mortgage involved, but the tax transcript will pick up any of the second-home costs they deducted.
A too-small payment for estimated taxes. If you’re self-employed and pay estimated taxes, you might try to conserve cash by making a smaller-than-usual tax payment. That could be a mistake, since a lender might decide the smaller payment is a sign your income is declining.
No transcript. It can take up to five weeks for a transcript to be available after a return is filed. So if you got an extension to file your return and didn’t do so until the Oct. 15 extended deadline, your transcript won’t be available for several more weeks, which could endanger your deal.
Review your tax returns with your mortgage lender when you apply to see whether there are any red flags.
7. You can’t get Private Mortgage Insurance (PMI).
You still can get approved for a loan equal to up to 97% of a home’s appraised value. To do so, however, you’d need to get approved for Private Mortgage Insurance. And PMI companies, severely hurt by increased foreclosures, are being pickier than ever before.
If you’re the ideal borrower — credit scores of 720 or above, with a debt load below 40% of your income and several months’ worth of expenses in the bank — you might get approved for PMI to allow you to borrow up to 95% of a home’s purchase price in a flat or improving market, but not in a declining market. FHA offers loans with 3.5% downpayment, but typically have a higher interest rates.
A bigger down payment gives you more options and better rates.
8. The condo association isn’t approved.
Mortgage buyers are enforcing guidelines on condo purchases, as well as imposing new restrictions.
Some that you might stumble into include:
The 10% ownership rule. If anyone owns more than 10% of the units in a building, you probably won’t be able to get a loan. Lenders are worried that if this big owner defaults, the remaining owners won’t be able to pay for proper maintenance. Yet 10%-plus ownership stakes are pretty common, particularly where apartments were converted to condos or co-ops and the original owner hung on to units to rent.
The fidelity bond. Associations are supposed to buy a bond to protect against theft by management company employees. Many skated along with small bonds, but now lenders want to see more coverage. “A lot of (associations) had $50,000, and now you might need $400,000. The actual cost of increasing the bond is usually just a few hundred dollars a year, but board members may not understand the importance of this requirement and resist coughing up the extra cash.
Cash reserves. Condo associations should generally have cash reserves equal to 60% of the association fees they collect over the year, to make sure they have sufficient reserves to pay for needed maintenance and repairs. Many associations fall short of this mark. As above, owners who aren’t actively trying to sell their properties may not realize the importance of this requirement and may resist efforts to boost reserves.
If you’re buying a condo, talk to your lender about the requirements for condos and make sure the association meets the requirements before applying for a loan. Your Realtor should add a contract contingency for association review when making an offer on a condo.
9. Your lender is backlogged.
Like most other companies, the recession is creating shortage of workers, even if mortgage applications are piling up. If it takes too long to get your mortgage approved, and your rate lock timeframe expires, you could wind up paying a higher interest rate, or your purchase deal could fall through, particularly if the seller has another interested buyer.
Ask your lender how long it will likely take for your deal to get done. If the wait time is too long, consider switching to a company that can offer faster approval. In any case, monitor your loan and follow up frequently with your mortgage professional and any home equity lender to make sure it stays on track.
10. You don’t respond quickly to requests for documentation.
Your loan application will be heavily scrutinized. Lenders demand a ton of paperwork, and you should be prepared to prove anything and everything, especially your income and the source of your down payment.
Any missing document or oversight can delay your loan, which is why you need to respond instantly to your loan officer’s requests. Save your lender’s number on speed dial and be prepared to respond within hours to any document request, no matter how silly you think it is. If you resist requests your loan might not get done.