Tag: Mortgage

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7 Reasons Your Mortgage Application Was Denied

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

There are few things more nerve-racking for homebuyers than waiting to find out if they were approved for a mortgage loan.

Nearly 627,000 mortgage applications were denied in 2015, according to the latest data from the Federal Reserve, down slightly (-1.1%) year over year. If your mortgage application was denied, you may be naturally curious as to why you failed to pass muster with your lender.

There are many reasons you could have been denied, even if you’re extremely wealthy or have a perfect 850 credit score. We spoke with several mortgage experts to find out where prospective homebuyers are tripping up in the mortgage process.

Here are seven reasons your mortgage application could be denied:

You recently opened a new credit card or personal loan

Taking on new debts prior to beginning the mortgage application process is a “big no-no,” says Denver, Colo.-based loan officer Jason Kauffman. That includes every type of debt — from credit cards and personal loans to buying a car or financing furniture for your new digs.

That’s because lenders will have to factor any new debt into your debt-to-income ratio.

Your debt-to-income ratio is fairly simple to calculate: Add up all your monthly debt payments and divide that number by your monthly gross income.

A good rule of thumb is to avoid opening or applying for any new debts during the six months prior to applying for your mortgage loan, according to Larry Bettag, attorney and vice president of Cherry Creek Mortgage in Saint Charles, Ill.

For a conventional mortgage loan, lenders like to see a debt-to-income ratio below 40%. And if you’re toeing the line of 40% already, any new debts can easily nudge you over.

Rick Herrick, a loan officer at Bedford, N.H.-based Loan Originator told MagnifyMoney about a time a client opened up a Best Buy credit card in order to save 10% on his purchase just before closing on a new home. Before they were able to close his loan, they had to get a statement from Best Buy showing what his payments would be, and the store refused to do so until the first billing cycle was complete.

“Just avoid it all by not opening a new line of credit. If you do, your second call needs to be to your loan officer,” says Herrick. “Talk to your loan officer if you’re having your credit pulled for any reason whatsoever.”

Your job status has changed

Most lenders prefer to see two consistent years of employment, according to Kauffman. So if you recently lost your job or started a new job for any reason during the loan process, it could hurt your chances of approval.

Changing employment during the process can be a deal killer, but Herrick says it may not be as big a deal if there is very high demand for your job in the area and you are highly likely to keep your new job or get a new one quickly. For example, if you’re an educator buying a home in an area with a shortage of educators or a brain surgeon buying a home just about anywhere, you should be OK if you’re just starting a new job.

If you have a less-portable profession and get a new job, you may need to have your new employer verify your employment with an offer letter and submit pay stubs to requalify for approval. Even then, some employers may not agree to or be able to verify your employment. Furthermore, if your salary includes bonuses, many employers won’t guarantee them.

Bettag says one of his clients found out he lost his job the day before they were due to close, when Bettag called his employer for one last check of his employment status. “He was in tears. He found out at 10 a.m. Friday, and we were supposed to close on Saturday.”

You’ve been missing debt payments

During the loan process, any recent negative activity on your credit report, which goes back seven years, can raise concerns. The real danger zone is any activity reported within the last two years, says Bettag, which is the time period lenders play closest attention to.

That’s why he encourages loan applicants to make sure their credit reports are accurate and that old items that should have fallen off your report after seven years aren’t still appearing.

“Many things show on credit reports beyond seven years. That’s a huge issue, so we want to get dated items removed at the bureau level,” Bettag says.

For first-time homebuyers, he cautions against making any late payments six months prior to applying for a mortgage. They won’t always be a total deal-breaker, but they can obviously ding your credit, and a lower credit score can lead to a loan denial or a more expensive mortgage rate.

Existing homeowners, Bettag says, shouldn’t have any late mortgage payments in the 12 months prior to applying for a new mortgage or a refinance.

“There are workarounds, but it can be as laborious as brain surgery,” says Bettag.

You accepted a monetary gift

Your lender will be on the lookout for any out-of-place deposits to your bank accounts during the approval process. Bettag advises homebuyers not to accept any large monetary gifts at least two months or longer before you apply, and to keep a paper trail if the lender has any questions.

Any cash that can’t be traced back to a verifiable source, such as an annual bonus, or a gift from a family friend, could raise red flags.

This can be tricky for homebuyers who are relying on help from family to purchase their home. If you receive a gift of money for a down payment, it has to be deemed “acceptable” by your lender. The definition of acceptable depends on the type of mortgage loan that you are applying for and the laws that govern the process in your state.

For example, Bettag says, the Federal Housing Authority doesn’t care if a borrower’s entire down payment comes as a gift when they are applying for an FHA loan. However, the gifted funds may not be eligible to use as a down payment for a conventional loan through a bank.

You moved a large amount of money around

Ideally, avoid moving large sums of money about two months before applying.

Herrick says many borrowers make the mistake of shuffling too much cash around just before co-signing, making themselves look suspicious to bank regulators. Herrick says not to move anything more than $1,000 at a time, and none if you can help yourself.

For example, If you’re considering moving money from all of your savings accounts into one account to deliver the cashier’s check for the down payment, don’t do it. You don’t need to have everything in one account for the cashier’s check for your closing. You can submit multiple cashier’s checks. All the lender cares about is that all of the money adds up. You may be able to simply avoid some of this hassle by arranging to pay using a wire transfer. Just be sure to schedule it in time.

You overdrafted your checking account

If you have a credit issue already, says Bettag, overdrafting your checking account can be a deal-breaker, but it won’t cause as much of an issue if you have great credit and offer a good down payment. Still avoid overdrafting for at least two months prior to applying for the mortgage loan.

You may be the type to keep a low checking account balance in favor of saving more money. But if an unexpected bill could risk overdrafting your account, try keeping a few extra dollars in the account for padding, just in case.

You forgot to include debts or other information on your loan application

Your loan officer should carefully review your application to make sure it’s filled out completely and accurately. Missing a zero on your income, or accidentally skipping a section, for example, could mean rejection. A small mistake could mean losing your dream home.

There’s also the chance you accidentally omitted information the underwriter caught in the more extensive screening process, like money owed to the IRS. Disclose all of your debt to your loan officer up front. Otherwise, they may not be able to help you if the debt comes up and disqualifies you for your dream home later on.

If you owe the IRS money and are in a payment plan, Bettag says your loan officer can still work with you. However, they want to see that you’ve been in a plan for at least three months and made on-time payments to move forward.

“Can you imagine not paying your IRS debt, getting into a payment plan, and then not paying on the agreed plan? Not cool for lenders to see, but we do,” says Bettag.

The Bottom Line

There is no hard and fast rule on how long before you begin the mortgage process that you should heed these warnings. It all varies, according to Bettag. If you have excellent credit and a strong income, you might be able to get away with a recently opened credit card or other discrepancies — minor faults that might totally derail the application of a person who has bad credit and inconsistent income.

Whatever the case may be, Bettag encourages prospective homebuyers to stick to one general rule: “Don’t do anything until you’ve consulted with your loan officer.”

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Mortgage

Risks to Consider Before Co-signing Your Kid’s Mortgage

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Homeownership is a cornerstone of the American Dream for most, but many millennials are finding it difficult to afford to buy in.

Overall, millennials are still far behind in homeownership compared to previous generations were at their age. Only 39.1% of millennials lived in a home they owned in 2016 compared with 63.2% of Gen Xers, according to an analysis by Trulia Economist Felipe Chacón.

Student debt and stagnant incomes could share some of the blame. Millennials earn 78.2 cents for every dollar a Gen Xer earned at their age, Chacón found. Nearly half of millennial homebuyers report carrying student loan debt, according to the 2016 National Association of Realtors Home Buyer and Seller Generational Trends survey. They carry a median loan balance of $25,000.

Loan officers have to take a borrower’s total debt picture into account when running their application, and it’s become increasingly hard to qualify for a mortgage with a vast amount of student debt.

When they can’t get approved for a mortgage, it’s common for homebuyers to seek out a co-signer for their loan. Often, that person is a parent.

Co-signing a child’s mortgage loan is a serious decision, and parents should weigh all of the risks before making any promises. We asked financial experts what risks are worth worrying about to help clear out the noise.

1. You’re on the hook if your kid stops making mortgage payments

When you co-sign a loan, you agree to be responsible for payments if the primary borrower defaults. If you’re expecting to retire during the life of the mortgage loan, co-signing is an even larger risk, as you may be living on fixed income.

Dublin, Ohio-based certified financial planner Mark Beaver says he’d be wary of a parent co-signing a mortgage for their adult child. “If they need a co-signer, it likely means they cannot afford the house, otherwise the bank wouldn’t require the co-signer,” says Beaver.

By co-signing, you effectively take on a risk the bank doesn’t want. And the list of potential scenarios in which your child may no longer be able to afford their house payments can be vast.

“What if your daughter marries a jerk and they get divorced, or he/she starts a business and loses money, or doesn’t pay their taxes. The risk is ‘what can happen that can make this blow up,’” says Troy, Mich.- based lawyer and Certified Financial Planner, Leon LaBrecque.

Bottom line: If you wouldn’t be able to comfortably afford the payments in case that happens, don’t co-sign.

2. You’re putting your credit at risk

A default isn’t the only event that could negatively affect your finances. The mortgage will show up on your credit report, too, even if you haven’t taken over payments. So, if your child so much as misses one payment, your credit score could take a hit.

This may not be the end of the world for an older parent who doesn’t anticipate needing any new lines of credit in the future, Beaver says, but it’s still wise to be cautious.

You might think your child is ready to become a homeowner, but a closer look at their finances may reveal they aren’t yet that financially mature. Don’t be afraid to ask about their income and spending habits. You should have a good idea of how your child handles their own finances before you agree to help them.

“Sure, we don’t want to meddle and pry into our children’s business; however, you are putting yourself financially on the line. They need to understand that and be open about their own habits,” says Andover, Mass.-based Certified Financial Planner John Barnes.

3. Your relationship with your child could change

Co-signing you child’s mortgage is bound to change the dynamics of your relationship. Your financial futures will be entangled for 15 to 30 years, depending on how long it takes them to pay off the loan.

Seal Beach, Calif.-based certified financial planner Howard Erman says not to let your feelings get in the way of making the correct decision for your budget. Think of how often you communicate and the depth and strength of your relationship with your child. If saying no might create serious tension in your relationship, you likely dodged a bullet.

“If your child conditions their love on getting money, then the parent has a much bigger problem,” says Erman.

Similarly, you should consider how your relationship would be affected if somehow your child ends up defaulting on the mortgage, leaving you to make payments to the bank.

4. You might need to let go of future borrowing plans

Co-signing adds the mortgage to the debts on your credit report, making it tougher for you to qualify for additional credit. If you dreamed of one day owning a vacation home, just know that a lender will have to consider your child’s mortgage as part of your overall debt-to-income ratio as well.

Although co-signing a large loan such as a mortgage generally puts a temporary crimp in your ability to borrow, keep in mind you may be affected differently based on the dollar amount of the mortgage loan and your own credit history and financial situation.

How to Say “No” to Co-signing Your Child’s Mortgage

There is a chance you’ll need to deny your child’s request to co-sign the loan. If you feel pressured to say yes, but really want to say no, Barnes suggests you say no and place the blame on a financial adviser.

“Having [someone like] me say no is like a doctor telling a patient he or she can’t run the marathon until that ankle is healed. It is the same principle,” says Barnes.

He advises parents facing the decision to co-sign a loan for a family member to meet with a financial planner to analyze the situation and give a recommendation for action.

If you choose to take the blame yourself, you may want to take the time to explain your reasoning to your child if you feel it’s warranted. If you said no based on something they can change, give them a plan to follow to get a “yes” from you instead.

LaBrecque suggests that parents who want to help out but don’t want to take on the risks of co-signing instead give the child a down payment and treat it as an advance in the estate plan. So if you “gift” your kid $30,000 to make the down payment, you would reduce their inheritance by $30,000.

The “gift the down payment” method grants you some additional benefits too.

“[The] method has a more positive parent/child relationship than the potential awkwardness of Thanksgiving with the kid(s) and late payments on the mortgage. Also, the ‘down payment gift’ is a quick victory. The kid’s now made their bed with the mortgage; let them sleep in it,” says LaBrecque.

Similarly, you could choose to help your child pay down their debts, so they’ll be in a better position to get approved on their own.

If you must say no, try to do so in a way that will motivate them toward the goal rather than deflate them. Erman recommends lovingly explaining to your child how important it is for them to be able to achieve this success on their own.

How to Protect Yourself as Co-signer

The best way to protect yourself against the risks of co-signing is to have a backup plan.

“If a child is responsible with money, then I generally do not see a problem with co-signing a loan, provided insurance is in place to protect the co-signer (the parent),” says Barnes.

He adds parents should make sure the child, the primary borrower, has life insurance and disability insurance in case the widowed son or daughter-in-law still needs to live in the home, or your child becomes disabled and is unable to work.

The insurance payments will also help to protect your own credit history and future borrowing power in case your child dies or becomes disabled. But these protections would be useless in the event your child loses their job.

If that happens, “insurance will not pay your bill unfortunately, so even if you are well insured, budgeting is vitally important,” Beaver says.

If you choose to take on the risk and co-sign, Barnes says to make sure you and your child have a plan in place that details payment, when to sell, and what would happen if your child is unable to make payments for any reason.

Additionally, LaBrecque recommends you get your name on the deed. Don’t forget to address present or future spouses. Ask your lawyer about having both kids sign back a quit-claim deed to the parent. If you get one, he says, you’ll be protected in case the marriage goes south, or payments are made late, because you would be able to remove a potential ex off the note.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Mortgage

Guide to Getting the Best Rate on Your Mortgage

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Guide to Getting the Best Rate on Your Mortgage

A house is the single largest asset that most Americans will ever buy. The median price of a home sold in the United States is up to $301,300, and the median household income of a homeowner is $60,000. This means that a house now costs more than five times the income of a typical homebuyer.

With prices so high, it’s more important than ever to find a great rate on your mortgage. Finding the lowest rate can save you tens of thousands of dollars over the lifetime of a loan. But finding the best rates on the loans with the right features can be a challenge. In this guide we’ll teach you how to find the best mortgage rates.

Finding the best rate on a mortgage

When it comes to buying a house, you don’t just need to house hunt; you need to shop for a mortgage. According to the Consumer Financial Protection Bureau (CFPB), just 53% of Americans shop for mortgages, but comparing lenders has a huge payoff. Saving 1% on your rate will save you tens of thousands of dollars over the life of your loan. Your mortgage can make or break the affordability of a house, and it’s up to you to find the best rates. These are the steps you can take to find the best rates.

Compare rates using the CFPB’s handy tool

The CFPB offers a tool that allows you to compare the prevailing interest rates on various types of loans. To use the tool, you need to know your credit score, the amount you intend to borrow, and how much money you have for a down payment.

By exploring the different options, you can determine the best rates in your state, and the most common rates.

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This tool will give you an idea of the rate landscape in your state. However, you still need to do work to get the best rates.

Next, find lenders that offer the lowest rates

Once you know the lowest interest rates, you can find the lenders offering those rates through search engine queries. Enter the following formula: “State Mortgage, X% Interest Rate, Loan Type.”

For example, “Alabama Mortgage, 3.75% Interest Rate, 30-Year Fixed Rate.”

The bank or credit union with the best rate should emerge near the top of the search rankings. You will find mortgage comparison websites that will help you connect with the banks. Mortgage comparison websites can be a helpful resource, but they require your contact information. If you use a comparison site, expect to receive phone calls or email solicitations.

Continue to cross-reference the rates from comparison sites with information from the CFPB. The rates on a mortgage comparison site should be as good as those on the CFPB’s site.

If a lender has already pre-approved you, they may be willing to match the lowest rate. Talk with your loan officer about the rate you saw on the CFPB’s website. Ask them to match the rate. If they will, the conversation saves you time and money.

Get pre-approved for a mortgage from multiple banks

Once you find the banks with the best rates, consider getting pre-approved for mortgage rates from a few different banks. A pre-approval means that a bank plans to give you a loan at a given rate. You will need to submit documentation to a loan officer to get pre-approved. Typical documentation includes W-2 forms, tax returns, credit reports, and evidence of assets.

The bank will review your documentation and give you a pre-approval letter. The letter explains how much you can borrow and at what rate. If you’re denied at this stage, you can find out why.

A pre-approval is not a contract. It is not subject to underwriting or an appraisal. Rates can change after you get a pre-approval. That’s why we recommend getting multiple pre-approvals if you can.

When you’re pre-approved, a bank will give you a letter that you can submit with offers on a home. Home sellers want to see a pre-approval letter because it means that you’re likely to have access to the financing to close a deal.

Once you have pre-approvals in hand, start shopping for houses. You can submit a bid and negotiate a price using your pre-approvals.

Request loan estimates from lenders

Once a seller accepts your bid, request loan estimates from all the banks that pre-approved you.

A loan estimate is a three-page document that contains an estimated interest rate, monthly payments, and closing costs for the specific loan. It explains everything you need to know about the loan if you choose to move forward.

Compare all the loan estimates before committing to a particular mortgage lender. Loan estimates allow you a true apples-to-apples comparison of interest rates.

A loan estimate isn’t a contract. The bank may deny the loan based on the home’s appraisal values or due to underwriting problems. But a loan estimate will allow you to make an informed decision.

Factors that influence your interest rate

Shopping for a mortgage isn’t the only way to find the best interest rate. You can influence the rate by controlling these factors.

Credit score

The better your credit history, the better your rate will be. In some cases, the difference can be a full percentage point or more. Fixing your credit score is one of the best ways to influence your mortgage rate. Depending on your credit history, you might be able to fix your credit score on your own within a few months.

When you’re shopping for a mortgage, pay your bills on time and keep your credit usage low. Try to use 10% or less of your total available credit. Don’t close old credit accounts or apply for new accounts when mortgage shopping. These actions promote a high credit score while you shop for a mortgage.

Down payment & PMI

In general a bigger down payment means a lower interest rate.

If you put down at least 5%, you will probably qualify for the lowest advertised rates. But don’t confuse the lowest interest rates with the lowest cost financing. Most banks require you to purchase private mortgage insurance (PMI) if you don’t put at least 20% down on a home. PMI adds about .5%-1% per month on your mortgage. You won’t be able to remove PMI until you’ve built up at least 20% equity in your home. You build equity when your home rises in value and when you pay down your mortgage.

If you have a down payment less than 5%, you’ll need to look at FHA loans or VA loans. VA loans don’t require PMI, but you will have to pay an upfront financing fee. This is a fee that doesn’t help you build equity, but VA loans have competitive rates for people who don’t have a down payment. Check the fee schedule for VA loans to see if the financing fee is worth it to you.

FHA loans require just a 3.5% down payment, but FHA loans have require mortgage insurance premiums (MIP). The MIP is an upfront fee (usually 1.75% of the total mortgage) and monthly interest rate hike of around .5%. You can’t get rid of MIP unless you get rid of your FHA loan.

Location

Buyers looking for a mortgage in a rural area may see higher rates compared to equally qualified buyers in nearby urban areas. Most lenders have less familiarity with lending in rural areas. This leads to higher rates. In rural settings, you may get the best rates from nearby banks and credit unions.

Rates also differ on a state-by-state basis. States that have laws that make foreclosure difficult tend to have higher mortgage rates than states with looser foreclosure laws. Likewise, states that require lenders to have a physical presence in the state raises interest rates.

Loan size

Interest rates on small mortgages (less than $50,000) tend to be higher than rates on typical mortgage sizes. Small mortgages are less profitable than other loans, and many banks won’t issue this size mortgage. Borrowers may need to work with local banks or credit unions or government lending programs to find a micro-mortgage.

At the other end of the spectrum, jumbo mortgages tend to track closely to conforming loan interest rates. Banks can’t sell jumbo loans in the secondary market, so they are riskier for the bank compared to other mortgages. Usually, banks compensate higher risk with higher interest rates. However, the rigorous underwriting on jumbo loans may drive many poor prospects out of the market.

Length of loan (Loan term)

Mortgages with shorter terms have lower rates than those with longer terms. A longer term represents more risk for the bank. Banks compensate their risk with higher interest rates. This doesn’t mean that a shorter term loan is always the right choice. Choose the loan term that fits your needs before you compare rates. That way you’ll get the best interest rate on the right mortgage for you.

Fixed or variable rates

Adjustable-rate mortgages put more risk onto borrowers. You’ll initially pay a lower interest rate if you take out an adjustable-rate mortgage, but the rate might increase.

When you’re considering an adjustable-rate, learn when and how the interest rate adjusts. Most loans adjust based on a set index. In a low interest rate environment, you can expect rates to increase, but you need to guess how much. Weigh whether the low rates now are worth a potential high rate in the future.

Conforming vs. FHA vs. VA vs. conventional

The company that backs your loan may seem unimportant, but it influences your rate.

Conforming loans (those that can be purchased by Fannie Mae or Freddie Mac, the largest purchasers of mortgage loans in the U.S.) tend to have the lowest interest rates. Despite their low interest rates, conforming loans are profitable for banks. Banks can easily sell conforming loans to Fannie Mae or Freddie Mac and reinvest the proceeds in making more loans. Conforming loans require at least a 5% down payment and good credit. For conforming loans, put 20% down to avoid paying PMI.

FHA loans have more lenient down payment and credit standards. They tend to be expensive for well-qualified buyers. However, an FHA loan may be the right option if you have a low down payment or a poor credit score. Only you can determine if the extra cost is worth it for you. VA loans are available to veterans, and they charge an upfront fee. However, they offer competitive rates for first-time homebuyers. If you can qualify for a VA loan, look into it as an option.

Conventional loans can’t be purchased by Fannie Mae or Freddie Mac. They require more shopping around to find the best rates. Not every lender issues conventional loans. If you qualify, the rates should be competitive with rates on conforming loans.

If you’re taking out a jumbo mortgage, you need to qualify for conventional underwriting. Likewise, condo buyers may need to qualify for a conventional loan. Fannie Mae and Freddie Mac will not purchase a mortgage if the property is part of an association that has more than 50% renter occupants.

Buying points

Many lenders offer to let borrowers buy “discount points” off of a mortgage. This means that you pay a set fee in exchange for the lender to lower your rate. In some circumstances buying discount points makes sense. Divide the cost of the point by the change in your monthly payment. This will tell you the number of months it takes for the prepayment to pay off (in terms of savings). If you expect to stay in the house significantly longer than the payoff period, go ahead and purchase the points. Otherwise, pay the higher interest.

Closing costs

An advertised interest rate doesn’t account for your total cost to borrow money. Most banks make their real money by charging closing fees. Banks might charge loan origination fees, recording fees, title inspection fees, underwriting fees, and application fees.

All the financing charges will be disclosed on a loan estimate. The loan estimate will also provide you with an annual percentage rate (APR), which expresses the total cost of borrowing money including the financing fees.

Special programs

Cities and states often issue special interest rates on loans for homebuyers who meet certain criteria. For example, Raleigh, N.C., subsidizes a $20,000 down payment loan for low-income, first-time homebuyers in distressed neighborhoods. Check your city, county, and state websites to see if you qualify for special rate programs. These programs often have favorable borrowing terms in addition to great rates.

Accelerating payments

Some borrowers cut their total interest costs by accelerating their mortgage payoff. If you make a half mortgage payment every two weeks, you’ll make an extra mortgage payment every year. This cuts a 30-year mortgage down to 23 years.

Making extra payments early in the life of your loan will help you achieve 20% equity faster. This will allow you to drop PMI payments or refinance at a lower rate.

Determining a budget for your loan

Finding a great rate on a loan that you can’t pay back is a sure way to destroy your credit. Before you apply for a loan, establish a realistic budget for your monthly mortgage payment. Avoid borrowing more than you can comfortably pay back.

When banks approve you for a mortgage, they will lend based on your current debt-to-income ratio without considering your other costs of living. Lenders have some limits, but you need to establish your own limits. Most of the time, lenders will not extend mortgage loans to borrowers whose monthly debt liabilities eat up more than 43% of their gross monthly income.

To understand debt-to-income ratio, consider this example. A person with a $60,000 annual income and a $500 monthly car payment applies for a mortgage.

A bank will allow them to carry a debt load up to $2,150 per month (($60,000/12)*43%). The bank subtracts the $500 from the maximum allowed debt load and determines that this person can afford $1,650 in house payments each month.

The bank in this example determines that $1,650 a month is an affordable budget.

No matter how large a loan you can get, you need to be a savvy consumer. The Consumer Financial Protection Bureau recommends that your entire housing payment (including taxes, insurance, and association dues) should take up no more than 28% of your gross income.

The CFPB’s advice may seem too strict, but you need to determine your non-mortgage-related cost of living before committing to a new loan. Calculate costs like income taxes, transit expenses, and child care or education costs. If you pay alimony or for out-of-pocket health care, consider those costs too. Plus, you’ll need to factor in the costs of home maintenance. Experts recommend setting aside 1%-3% of your home’s purchase price for maintenance and upgrades.

A 43% debt-to-income ratio may be manageable for people who expect a significant salary bump in the near future. But for many, such a high ratio could get you into credit trouble.

If you’re seriously shopping for houses, use Zillow’s advanced affordability calculator to determine how much mortgage makes sense for you. You can also learn if buying makes financial sense by using the Rent vs. Buy Calculator from realtor.com.

Before you start shopping for houses, determine how a mortgage will fit into your budget. Don’t succumb to pressures to overextend your budget. A burdensome mortgage has the power to turn a dream house into a nightmare. You can avoid the nightmare by planning ahead.

Determining loan features you want

In addition to establishing a budget, you need to understand how to find the right features on a mortgage. A great rate on a bad mortgage could spell financial ruin. When you’re shopping for loans, ask yourself these questions:

How long will you stay in the home?

Some buyers purchase houses with the intention of staying just a few years. Someone who plans to sell in a few years might consider a lower interest rate adjustable mortgage. However, an adjustable-rate mortgage is risky for someone who intends to live in a home long term.

How risky is your financial situation?

Do you and your partner have two steady jobs and a large cash cushion? In such a stable situation, you might feel comfortable putting 20% down. You might also feel good locking into a 15-year mortgage to save on interest.

People with less stable income and finances might feel more comfortable with a smaller down payment and a longer payoff period. This will mean paying PMI and higher financing costs, but they can be worth it for peace of mind.

Do you expect to have better cash flow in the future?

If you think that you’ll have more accessible cash flow in the future, you can borrow near the higher end of your limits today. An interest-only loan will allow you to get into a house with lower payments now and higher payments in the future. Of course, you need to be realistic about your future expectations. Your future income may be more modest than you hope, or you may face high costs in the future. An interest-only loan could leave you trapped in a house if housing prices decline.

Even if you expect a higher income, borrowing near the top end of your budget could keep you “house poor.” If the raise doesn’t pan out, you’ll be stuck in a house that you can’t comfortably afford.

Do you have access to other sources of financing?

Alternative sources of financing like a home equity line of credit make a loan with a balloon payment more viable. Alternative financing means that you’ll have options if your original mortgage payoff plan falls through.

Anyone considering a balloon payment loan should have a solid lead on alternative financing before they take out the loan.

How much cash do you have for a down payment?

You can purchase a house with almost no money down. For example, the Federal Housing Association (FHA) offers “$100 Down” home financing on select HUD homes, or down payments as low as 3.5% for FHA-backed loans. Veterans can purchase homes using $0 down VA loans.

On the other hand, if you have more money to put down, you may qualify for a conventional mortgage or a mortgage backed by Fannie Mae or Freddie Mac. The more cash you have, the more options you have for loan types.

Do you have compelling uses for cash outside of a home down payment?

Putting a large amount of money down on your home locks up the cash. You can access home equity through a home equity line of credit, but that introduces a new element of risk. Even if you have a large amount of cash, you may not want to use it to fund a down payment. For example, you may want to hold cash for an emergency fund, to start a business, or to fund some other purchase.

If you have a compelling reason to hold onto cash, you may intentionally narrow your mortgage search to low down-payment options.

How quickly do you want to pay off your house?

A paid-off home might be your top financial priority. In that case, you might want to look for options with a short payoff period. For example, you might prioritize the forced savings of a 15-year mortgage. You might even aim to payoff a 5/1 ARM before the first rate adjustment if you have sufficient cash.

How important is the monthly payment?

A lot of people prioritize a low monthly payment above any other factor. You can achieve a low payment by avoiding fees (like PMI), finding the lowest possible interest rate, and extending the terms of the loan. Even more important than those factors is borrowing an amount that you can easily afford under most circumstances.

Common mortgage terms

Sometimes the most difficult part about shopping for a mortgage is understanding the terms that lenders use. Below we’ve defined a few of the most common mortgage terms that you should know before you sign a loan.

  • Interest Rate – The amount charged by a lender for a borrower to use the loaned money. This is expressed as a percentage of the total loan amount.
  • APR – The annual percentage rate is the total amount that it costs to borrow money from a lender expressed as a percentage. The APR factors in closing costs and other financing fees.
  • Amortization Schedule – A table that shows how much of each payment goes to the principal loan balance versus the interest portion of the loan.
  • Term – A set period of time over which a fixed loan payment will be due (often 15 or 30 years).
  • Fixed-Rate Mortgage – A mortgage where the interest rate stays the same for the entire term of the loan.
  • Adjustable-Rate Mortgage – A mortgage where the interest rate changes based on factors outlined in the loan agreement. Often, the adjustment is tied to a certain publicly available interest rate like the Federal Exchange Rate. Adjustable-rate mortgages are considered riskier than fixed-rate mortgages due to the potential volatility of payments. Adjustable-rate mortgages (ARMS) include:
    • 1-Year ARM – A mortgage where the interest rate adjusts up to once per year for the life of a loan.
    • 10/1 ARM – A mortgage where the interest rate is fixed for ten years and then increases up to once per year for the remaining life of the loan.
    • 5/1 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every year for the life of the loan.
    • 5/5 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every five years for the life of the loan.
    • 5/25 ARM – Also known as the five-year balloon mortgage. A 5/25 loan is a subprime loan with a fixed rate for the first five years of the loan. If a borrower meets certain standards (usually a record of on-time payments), they will receive the right to refinance the remaining 25 years on an adjustable-rate mortgage. Otherwise, the bank requires a “balloon” or remaining balance payment after five years.
    • 3/1 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once per year for the life of the loan.
    • 3/3 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once every three years for the life of the loan.
    • Two-Step Mortgage – A mortgage that offers a fixed interest rate for a fixed period of time (usually 5 or 7 years). After the fixed period, the rate adjusts to current market rates. Often, the borrower can choose either a fixed rate or an adjustable rate during the second step.
  • Interest-Only Mortgage – A mortgage where a borrower pays only the interest on a loan for a fixed period (usually 5-7 years).
  • PMI – Private mortgage insurance is a product that protects a bank if you default on your mortgage. Lenders often require borrowers with less than 20% equity to purchase PMI.
  • Jumbo Mortgage – A mortgage that is larger than the standards for a “conforming loan” set by government-backed agencies. In most parts of the U.S. a jumbo loan must be larger than $417,000. In some of the highest cost of living areas, a jumbo is in excess of $625,000.
  • Fannie Mae – The Federal National Mortgage Association is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Freddie Mac – The Federal Home Loan Mortgage Corporation is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Conforming Loan – A mortgage that meets the funding criteria of Fannie Mae and Freddie Mac. The most stringent criteria is the loan size.
  • FHA Loan – A loan guaranteed by the Federal Housing Administration. Qualifying standards are not as stringent, but the fees are higher. In addition to a monthly premium (similar to PMI), borrowers pay a “borrowing” premium when they take out the loan.
  • VA Loan – A mortgage guaranteed by the Department of Veterans Affairs. Veterans can purchase houses with a $0 down payment when using a VA loan, provided the veteran meets other lending criteria.
  • Conventional Mortgage – A mortgage that is not guaranteed by any of the federal funding agencies. Certain homes or condominiums will only qualify for a conventional mortgage financing option.
  • Down Payment – The initial payment that a homebuyer supplies when purchasing a home with a mortgage.
  • Balloon Mortgage – A mortgage where a borrower pays fixed payments for a period of time (usually 5 or 7 years) after which the balance of the loan is due. This is considered a high-risk loan.
Hannah Rounds
Hannah Rounds |

Hannah Rounds is a writer at MagnifyMoney. You can email Hannah at hannah@magnifymoney.com

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Guide to Reverse Mortgages: Is the Income Worth the Risk?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

old senior couple at home house on couch

If you own a home, chances are you’ve heard of a reverse mortgage. Despite increased attention and regulation, many homeowners still struggle to understand what reverse mortgages are and who should consider one. This guide will provide an in-depth understanding of exactly what a reverse mortgage is and the pros and cons of this complex financial product.

What is a reverse mortgage?

Most homeowners are familiar with a regular mortgage: You borrow money from a lender to purchase a home, then repay the loan in monthly installments over the course of several decades.

With a reverse mortgage, the lender pays you by taking some of your home’s equity and converting it into monthly payments to you. As long as you live, remain in your home, and continue to meet other obligations of the mortgage (discussed in more detail later), you do not have to pay the money back.

When you die, sell the home, or move out, you or your spouse or estate will have to repay the loan. If you signed the loan paperwork but your spouse didn’t, your spouse may be able to continue living in the home after you die, as long as they continue to pay property taxes, insurance, and maintenance costs. However, your spouse will cease to receive monthly payments from the reverse mortgage, since he or she wasn’t a part of the loan agreement. Once your spouse passes away or moves out of the home, your family or heirs may need to sell the home to repay the loan.

Example of how a reverse mortgage works

James and Mary, ages 73 and 72, are a retired couple who own their home outright. They want to stay in their home but need to supplement their monthly income from Social Security and James’s pension. They would also like to remodel their kitchen. James and Mary’s home is valued at $250,000, and they do not have a mortgage.

The total amount that James and Mary can borrow using a reverse mortgage is limited by the Federal Department of Housing and Urban Development (HUD) and is based on the age of the youngest spouse, current mortgage rates, and the value of the home.

Let’s run a hypothetical scenario through the National Reverse Mortgage Lenders Association’s reverse mortgage calculator.

Value of the home $250,000
Loan principal limit $150,000
Closing costs -$7,800
Net principal limit $142,200
Lump sum cash for kitchen remodel -$20,000
Remaining for monthly advance $122,200
Monthly advance $750

James and Mary have been mortgage-free for a year. The current value of their home is $250,000, and they are applying for a $150,000 reverse mortgage. After accounting for closing costs of approximately $7,800, the remaining available principal is $142,200. James and Mary would like to have $20,000 of that up front for the kitchen remodel, leaving $122,200 available for monthly installments. Based on this scenario, the amount James and Mary would receive monthly is approximately $750.

Reverse mortgage requirements

Businesswoman pushing button on touch screen

To qualify for a reverse mortgage, you must:

  • Be age 62 or older
  • Own your home outright or have a small mortgage (meaning the amount you owe on the mortgage is less than the amount you qualify for under the reverse mortgage program)
  • Use the home as your primary residence
  • Not be delinquent on any federal debt, such as back taxes, federally backed student loans, SBA loans, or HUD-insured loans.
  • Have the financial resources to continue to meet obligations such as property taxes, homeowners insurance, association dues, and repairs
  • Participate in an information session with a HUD-approved Home Equity Conversion Mortgages counselor

Meeting these basic requirements doesn’t necessarily mean a reverse mortgage is right for you.

3 questions to ask yourself when considering a reverse mortgage

  • Do you want or need to move? This question should help you understand whether or not your home will continue to meet your needs for the foreseeable future. If your home is physically difficult for you to navigate and maintain, you may be better off selling the home and downsizing to a home that is better suited to your retirement years. A reverse mortgage requires you to continue to reside in and maintain the home. If you are physically or financially unable to do that, you may have to sell the home to pay off the loan balance.
  • Can you afford to continue paying real estate taxes, homeowners insurance, association dues, and maintenance? While a reverse mortgage will boost your monthly income, consider whether that additional cash flow will be enough to continue covering real estate taxes, insurance, association dues, and home maintenance. Keeping up with these obligations is a requirement of a reverse mortgage. If you cannot afford to keep up with these expenses and your other bills, including health care, utilities, and other living expenses, a reverse mortgage may not make sense.
  • Are you planning on leaving your home to your children, grandchildren, or other heirs? When you pass, your heirs may have to sell the home to pay off the reverse mortgage. Other assets, such as investments or life insurance, may be available to pay off the loan balance. If your sole motivation for staying in the home is to pass it on to heirs, consider whether they’ll be able to hold on to it after you are gone.

Robin Faison is a licensed mortgage loan officer specializing in reverse mortgages with Open Mortgage in Scottsdale, Az. Faison also teaches a Reverse Mortgage for Purchase class accredited through the Arizona Department of Real Estate.

Faison says reverse mortgage borrowers typically fall on a spectrum, from those who are facing foreclosure and need a reverse mortgage to keep their homes, to those who are not in any financial difficulty and use a reverse mortgage line of credit strategically as a part of their overall retirement plan.

Reverse mortgage risks

A reverse mortgage is a financial product, and all financial products come with risks. Make sure you understand those risks before signing any paperwork. Those risks may include the following.

Fewer assets for heirs

Some homeowners dream of holding on to the family home and passing it down to their children or grandchildren. If this is part of your estate plan, consider whether your heirs will need to sell the home to pay off the reverse mortgage.

Even if you have life insurance proceeds or other assets that can be tapped to pay off the reverse mortgage after your death, those assets may be depleted, leaving less for your family members. Work with your financial adviser and a reputable reverse mortgage specialist to make sure that a reverse mortgage works with your overall estate plan.

Fees and other costs

Real estate investment. House and coins on table

Just like with a conventional mortgage, you will pay closing costs, mortgage insurance premiums, origination fees, and other costs to close on a reverse mortgage. According to the Consumer Financial Protection Bureau (CFPB), the fees and other costs of a reverse mortgage vary based “on the type of loan you choose, how much money you take out up front, and the lender you choose.”

Faison says lenders also receive a premium for servicing your loan (typically from Fannie Mae or Freddie Mac), which can be used to offset closing costs. However, regulations have made it more difficult for banks to offset costs on a fixed rate loan. Your lender will have more leeway for offsetting closing costs with that premium on an adjustable rate mortgage, but then the borrower bears the risk of rising interest rates.

Will owe more over time

As you receive money from the reverse mortgage, interest is added to the balance you owe each month. The amount you owe grows as interest on the loan balance adds up over time. Faison says many borrowers choose to make some payments on their reverse mortgage in order to keep the loan balance down.

Variable rates

Most reverse mortgages have variable rates. While these loans have more flexibility than fixed rate mortgages, your rate can rise quickly and dramatically.

HUD publishes statistics on all federally backed reverse mortgages each month. For October 2016 (the most recent month for which information is available at the time of this writing), interest rates on adjustable rate reverse mortgages range from 2.507% to 6.045%.

Interest is not tax deductible

Unlike a traditional mortgage, the interest you’ll pay on a reverse mortgage is not tax deductible until the loan is paid partially or in full.

Need to continue paying other obligations

You will still be responsible for paying property taxes, insurance, utilities, fuel, maintenance, and other standard costs of keeping up the home, just as you would with a conventional or no mortgage. If you cannot or do not continue to pay real estate taxes or insurance or to maintain the home, the lender may require repayment of the reverse mortgage.

May require “set-aside” amounts

Lenders are required to conduct a financial assessment to ensure borrowers have the financial capacity to continue paying obligations such as property taxes, homeowners insurance, and maintenance. If the lender determines that the borrower may not be able to keep up with such payments, they may require “set-aside” amounts to cover future obligations.

The set-aside amount is based on a formula that takes into account your current property taxes and homeowners insurance premiums, projected increases to taxes and insurance rates, monthly interest rates, and the life expectancy of the youngest borrower. While set-aside amounts help ensure borrowers can continue to meet loan obligations, those amounts will reduce your payment amounts.

Unscrupulous advice

Some unscrupulous advisers try to pressure borrowers into using proceeds from a reverse mortgage to purchase other financial investments. The Financial Industry Regulatory Authority (FINRA) warns consumers to be skeptical of such advice. If those other investments lose value, you or your heirs may not have the means to pay off the reverse mortgage balance and may have to sell the home.

Primary residence requirement

Faison says she also reminds all of her clients about the obligation to continue using the home as your primary residence. You only need to live in the home for six months and one day out of the year for the home to qualify as a primary residence.

Annually, the lender will mail an affidavit that the borrower needs to complete, sign, and send back to confirm they are still there. Make sure to respond to those notices. Otherwise, the lender may believe you are no longer living in the home and take steps to collect on the loan balance.

How to shop for a reverse mortgage

Reverse mortgages are not one-size-fits-all products. Here are a few things to keep in mind when selecting a reverse mortgage.

Types of reverse mortgages

  • Single-purpose reverse mortgages. These are offered by some state and federal agencies and nonprofit organizations. As the name implies, the loans can be used for only one purpose, such as home repairs or improvements or property taxes.
  • Proprietary reverse mortgages. These are private loans without federal backing. Owners of higher-valued homes may receive bigger advances from a proprietary reverse mortgage.
  • Home Equity Conversion Mortgages (HECMs). HECMs are federally insured and backed by HUD. Proceeds can be used for any purpose. An HECM may be more expensive than a traditional home loan, but they offer more flexibility. Borrowers can choose several payment options, including:
    • Single disbursement
    • Fixed monthly advances over a specified period of time
    • Fixed monthly advances as long as you live in your home
    • A line of credit
    • A combination line of credit and monthly payments

Other considerations for choosing a reverse mortgage

Faison recommends working with a local licensed loan officer who specializes in reverse mortgages or HECMs. “It’s fine to work with companies you hear about on TV,” Faison says, “but I often work with people who heard about reverse mortgages on the television but then decide they want to work with someone local.”

No matter who you work with, make sure you understand all costs involved. Loan expenses, including origination fees, interest rates, closing costs, and servicing fees, can vary among lenders. Make sure you fully understand the total cost of the loan.

How long do reverse mortgages take?

Clock time deadline

Depending on where you live and how busy appraisers are in your area, it could take two months or more just to get an appraisal on your home, which is only the first step in the process.

Faison also recommends asking your loan consultant how long the reverse mortgage process will take. If you are facing foreclosure or need money right away, a reverse mortgage may take more time than you have. Faison says some lenders may take 60 days or more, depending on the appraisal. “The appraisal industry has undergone a lot of change recently, and there are fewer appraisers available,” Faison says.

Alternatives to a reverse mortgage

A reverse mortgage isn’t right for everyone. Faison speaks with many people who ultimately are not good candidates. Credit issues may stand in the way of passing a financial assessment. In other cases, homes haven’t been maintained and are unable to pass the appraisal process. These problems can be resolved. However, if they are impossible to overcome, alternatives to a reverse mortgage include the following.

Refinance existing mortgage

If you have an existing home loan, you may be able to refinance your mortgage to reduce your monthly payments and free up some cash.

Take out a home equity loan or line of credit

If you own your home outright, you may be able to take out a home equity loan or line of credit. You will still be responsible for monthly payments, but the interest on the loan is usually tax deductible up to $100,000.

Sell your home and downsize or rent

If you are willing and able to move, selling your home to downsize or rent will free up the equity in your home, giving you extra cash to save, invest, or spend. You could also sell the home to your kids or another family member. Often, people who sell the home to a family member use a sale leaseback agreement where they rent back the home using proceeds from the sale.

REX agreement

A REX agreement is an alternative to a home equity line of credit. It allows you to access the equity in your home, giving you a cash payment of a percentage of your home’s market value (typically 12% to 17%) in exchange for 50% of the increase in your home’s value when it is sold. For example, if the home is worth $100,000 when the REX agreement is signed, the homeowner may receive a cash payment of $12,000 to $17,000. If the home increases in value by $50,000 over the next 10 years, when the home is sold, the company receives $25,000 (50% of the $50,000 increase).

Rent out part of your home

If you want to stay in your home but need some additional income, you may be able to rent out a part of your home to a roommate. Be sure to screen candidates carefully.

The bottom line

If you are considering a reverse mortgage of any kind, make sure you understand the pros and cons of this complex financial product before you sign. The television commercials may make it look easy, but a reverse mortgage is a serious financial commitment that comes at a cost and may impact potential heirs.

If you do not have the money to continue living in your current home at your current lifestyle, borrowing money against your home equity may not be the best option. Discuss your situation with a trusted adviser and a reputable, licensed loan officer with experience in reverse mortgages and HECMs. If you do decide that a reverse mortgage is right for you, review the different types of reverse mortgages and shop around for the best terms and rates. Do some research to find a counselor or company who will take the time to help you understand the costs and obligations before making any decisions.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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What Credit Score Do You Really Need for a Mortgage?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Young Couple Moving In To New Home Together

When it comes to qualifying for a mortgage, your credit score is everything.

If your credit score is below the minimum cutoff, you will be rejected. But even if you are approved, your exact credit score will have a big impact on the total cost of your mortgage. The higher your credit score, the lower the interest rate you will pay.

The vast majority of mortgages in America are either “conventional” (which means the mortgage will be purchased by Fannie Mae or Freddie Mac) or “FHA.” If you are applying for a conventional or FHA mortgage, this post applies to you.

We will explain:

  • Which version of FICO will be used to determine your score
  • Which credit score will be used when your score differs by bureau
  • Which credit score will be used if you have a co-signer with a different score
  • What minimum credit score you must have in order to qualify and what scores generally get the best interest rates
  • Why you could still be rejected even if your score is above the minimum required
  • What to do if you don’t have a credit score

Which Version of FICO Will Be Used

There are a lot of “free credit scores” available. You might see your “official FICO” on your credit card statement, or you could be a customer of Credit Karma. Unfortunately, none of these scores are being used by conventional or FHA mortgage lenders. Ironically (and almost shockingly), older versions of FICO are still being used to make lending decisions. The version of the FICO score depends upon the credit bureau, and most lenders will pull reports from all three bureaus. Here are the scores you need:

  • From the Equifax credit bureau: FICO Version 5 (also called Equifax Beacon 5.0)
  • From the Experian credit bureau: FICO Version 2 (also called Experian/Fair Isaac Risk Model V2SM)
  • From the TransUnion credit bureau: FICO Version 4 (also called TransUnion FICO Risk Score, Classic 04)

The only way to get access to the credit scores used by mortgage lenders is to purchase your credit score from FICO. For $59.85 you can make a one-time purchase of all of your credit scores, including the relevant mortgage scores at myFICO.com. This is a steep price to pay, and for many people it is not necessary. Although the VantageScore (available at Credit Karma) and FICO Version 8 (which many credit card issuers share) are not the exact scores used in mortgage lending, they can be useful. If your credit score is above 740 on all of your “free” scores, you can feel highly confident that your mortgage scores will also be above 740. However, if your score is below 740, you might want to invest in knowing exactly what mortgage lenders will see.

Although FICO has made enhancements with each new credit scoring model (for example, there is now a FICO 9), the general rules have not changed. You will have a good score if you make your monthly payments on time, keep your credit card balances and utilization low, and avoid collection items and judgments. (You can learn more with our credit score guide).

What If My Score Differs Between Bureaus?

There are three national credit bureaus: Equifax, Experian, and TransUnion. Sometimes creditors or collection agencies do not report to all three bureaus. As a result, your credit score could be different at different bureaus. For example, a collection agency might have registered a collection item on only one credit bureau. As a result, your score could be 750 on one bureau (without the collection item) and 650 on the other bureau (with the collection item).

The rules are relatively simple:

  • If the mortgage company pulls a credit report from all three credit bureaus, it will use the middle credit score (not the lowest or the highest score). For example, if you have a 650, 680, and 710 across the three bureaus, the middle score of 680 will be used.
  • If the mortgage company only pulls two credit bureaus, the lower credit score will be used.

Most mortgage companies will not tell you their methodology. The only reason a mortgage company would limit the number of credit bureaus it uses is to save on costs. And it would not be in the interest of a mortgage company to advertise that it “does not pull from Experian.” If it did advertise that way, people with something to hide on the Experian credit bureau would apply in droves.

What If I Have a Co-Signer?

When two people apply for a mortgage, the rules are simple: the lower credit score is used.

A credit score will be assigned to each borrower, using the methodology described in the previous section (the middle of three scores or the lowest of two scores). The lower of those two scores would then be used.

Imagine two borrowers had the following scores:

  • Borrower A: 660, 680, and 700
  • Borrower B: 710, 720, and 730

Borrower A’s score would be 680 (the middle score), and Borrower B’s score would be 720 (the middle score). For the purpose of the loan application, the lower of the two scores would be used. So the official credit score for this application would be 680.

What FICO Score Do I Need to Qualify?

Each agency (Fannie Mae, Freddie Mac, and FHA) sets its own minimum credit score requirements. If your score is below the minimum, you will be rejected. However, having a credit score above the minimum does not mean you will automatically be approved. You will still have to pass other credit criteria (for example, debt burden and other rules).

Here are the minimum credit scores required by agency:

  • Fannie Mae and Freddie Mac: minimum credit score of 620.
  • FHA: minimum credit score of 500 with a 10% down payment. Once your score is above 580, you only need a 3.5% down payment.

In order to have the lowest rate, you will want your credit score to be above 740 and your LTV — loan-to-value ratio — to be below 60%. However, regardless of LTV, the lowest interest rates tend to go to people with scores above 740.

Lower credit scores become even more expensive when you have a smaller down payment. For example, if you have a 30% down payment and a 620 credit score, you would pay 1.25% more than someone with a 740 credit score. However, if you only have a 10% down payment, a 620 credit score will have a 3% higher interest rate than someone with a 740.

If you have a low credit score and a small down payment, it almost always pays to wait. Increase your down payment (by saving) and improve your credit score before applying, because the savings can be significant.

3 Reasons You Can Still Be Rejected for a Mortgage Loan

You might have a great credit score, but your mortgage application could still be rejected. Here are the three main reasons why:

  1. Many mortgage lenders have stricter requirements than the “minimum” set by the mortgage agencies. The government agencies (Fannie Mae, Freddie Mac, and FHA) set minimum standards. As a mortgage company, so long as your mortgages meet those minimum standards, you can sell the mortgages to the agencies. However, if too many borrowers of a mortgage company default, the government agency can stop working with the mortgage company. Even worse, the agency could sue the mortgage company. So (especially after the 2008 crisis), most mortgage companies have minimum score requirements that are a bit higher than the minimum. For example, one of the lowest FICO requirements for FHA mortgages is 540, even though — technically — a 500 score is allowed.
  2. Mortgage lenders set other credit policy rules. If your credit score is low because you don’t have a lot of history, you have a much better chance of being approved. However, if your credit score is low because you have a lot of negative marks on your credit report, it will be a lot harder to get approved. For example, a lender could have a minimum credit score of 640, but will not approve anyone who was 60 days or more delinquent in the last year. If your score is 640 because of a 60-day late payment, you are still out of luck.
  3. Down payment, verification, documentation, and all of the other requirements can still stop you. Just because you have a good credit score and pass all of the credit policy rules, there are still a number of other hurdles you need to jump over. You need to prove that you have sufficient income to handle the payments. You will need to have a down payment and sufficient reserves. And you will need to have a lot of documentation, especially if you are a freelancer.

You should think of the credit score as the minimum, first requirement. But don’t celebrate once you have the required score — there is still a lot more to do.

What If I Don’t Have a Credit Score?

If you do not have a credit score, you can still qualify for a mortgage. Just remember: there is a big difference between a bad score and no score. No score means that there is not sufficient information on your credit report to generate a credit score.

There is a special, manual underwriting process for people with no credit score. In general, you will have a higher burden of proof for both your income and your payment history. That means you will probably have to document proof of up to two years of income, and you will need to be able to document proof of payment. Some acceptable forms of payment history would include:

  • Rent payments made on time
  • Utility bill payments made on time
  • Phone or cable bills made on time

There are mortgage companies that specialize in helping people with no credit score. However, the best rates and easiest processes are available to people with scores above 740. If you want to start building your credit score now, open a secured credit card.

Nick Clements
Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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Many School Workers Can’t Afford to Live in the Communities They Serve

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Headshot angry woman with glasses skeptically looking at you

While you’re complaining about the traffic pileup as you drive past the local elementary school on your morning commute, you might not think about the bus driver who had to drive more than an hour to work that morning because he or she can’t afford to live in the school district.

That scenario is a reality for almost all bus drivers and a very similar experience for many other members of a school’s staff, according to a new study.

In Paycheck to Paycheck 2016, a study by the National Housing Conference’s Center for Housing Policy, researchers highlight the ability of five common school workers — the bus driver, child care teacher, groundskeeper, social worker, and high school teacher — to afford a median-priced home in more than 200 metro areas.

The Findings

High School Teachers Have It Best. On a median annual salary of $60,610, high school teachers could afford rent in 198 of the areas, or about 94%. However, they could only afford to pay mortgage for a median-priced two-bedroom home in just over half — 130 — of the 210 metro areas analyzed.

Bus Drivers, Not So Much. At the other extreme, the findings show that it’s virtually impossible for a bus driver making a median income in a single-income household to afford to rent or pay mortgage for a two-bedroom home in any of the 210 metro areas. The median annual national salary for bus drivers is $23,412, far less than the national median income of $53,483. The low wages make finding housing even more difficult.

Child Care Teachers. The study found that child care teachers, whose median national salary is $29,539, only make enough to afford rent on a standard two-bedroom home in 9 of the 210 metro areas, or only 4%. Living in the Bay Area in California, for example, would eat up about 75% of a child care teacher’s income in rent. Homeownership is almost equally difficult to achieve, with child care teachers at a median income unable to afford a mortgage in 94% of the metro areas.

Groundskeepers and Social Workers.
Groundskeepers earn a median $34,214, or 64% of the national median income, which makes them barely better off than child care teachers and bus drivers when it comes to affording housing. Groundskeepers could only afford to rent a home in 57 of the 210 metro areas and to own a home in only 25 metro areas.

Social workers, who may be assigned to multiple schools and sometimes multiple districts, are a little more housing-secure at a national median annual salary of $52,538. The average social worker could afford to rent a two-bedroom home in 90% of the metro areas, but could own a home in just above half, or 110 of the 210 areas.

Why We Should Care

Affordable housing for school workers matters, the study authors argue.

The consequences of unaffordable housing are more than an increased transportation expense for the school worker. Implications for a community can be numerous, ranging from losing good talent to having fewer extracurricular opportunities for kids in the district.

Janet Viveiros, the acting director of research at the National Housing Conference, noted that some school workers may reject a job offer from a school in a district with high housing costs simply because they won’t be paid enough to afford housing in the school district.

“If someone is facing a long commute every day, they may be unable or unwilling to take on additional responsibilities like coaching or mentoring,” Viveiros said. “Bus drivers may not be willing to take on an extra shift for extracurriculars.”

Measuring Housing Affordability

The researchers defined “affordable” as the ability to spend no more than 30% of the household’s income on rent and utilities or up to 28% of the household’s income on a mortgage.

When workers are able to keep housing costs below those limits, it “means that you have more money available for healthy food, for medical services” and other improvements to one’s quality of life, Viveiros said.

For the study, researchers only measured affordability for households where the school worker was the sole earner.

How Can School Workers Save?

Several federal and state-backed initiatives have been created to help school workers and other low-income workers afford housing in the communities they serve. Knowing your options and resources can help you save on housing costs.

Federal Help

For example, the HOME Investment Partnerships Program exists to subsidize new construction or rehabilitation of homes, or offer down payment assistance loans or grants. The assistance applies to households that make 80% or less of the area’s median income, a demographic which many of the workers in the study would fall into.

The Federal Housing Administration also offers low-cost financing for first-time homebuyers and lower-income households. FHA loans can lower the down payment to 3.5% of the home’s purchase price.

The Affordable Housing Program, run by the Federal Home Loan Banks, provides funding through member banks for the purchase, construction, or rehabilitation of homes owned by low- or moderate-income households.

The Housing Choice Vouchers Program (formerly Section 8) is the dominant federal rent subsidy program. It serves more than 3 million household and makes housing affordable by paying the difference between what a household can afford and the actual rent, up to a limit determined by the U.S. Department of Housing and Urban Development. However, the program is underfunded as only 1 in 4 households eligible are able to receive the help they need.

State Assistance

Multiple levels of programs and policies can be more beneficial to an area, as resources are slim and many programs lack sufficient funding for all who may qualify. Some states have their own programs as additional sources of assistance.

“There’s not one program at the federal level, state, or local level,” said Viveiros. “It’s really about pulling together a variety of policies and programs” from all levels of government.

Massachusetts has the ONE Mortgage Program, which combines down payment assistance to help first-time, low-income homebuyers save on fees and mortgage insurance. It also gives an interest rate buydown into a single mortgage. The state also has a Rental Voucher Program, which is a lot like the federal Housing Choice Vouchers Program.

In Minnesota, the Minnesota Housing Trust Fund assists with rental assistance for low-income households.

The Arizona Housing Finance Authority has a HOME Plus program, which assists households with good credit through grants toward down payments or closing costs.

Education-Specific Policies and Programs

Some state and local governments have created programs and policies that address the specific affordable housing needs of education workers in their area.

The Connecticut Housing Finance Authority has a program specific to educators called the Teachers Mortgage Assistance Program. The program gives below market rate loans to teachers who work in districts that have a hard time attracting teachers. In addition to the low rate, teachers under this program also automatically qualify for a down payment assistance loan from the CHFA.

The Texas State Affordable Housing Corporation’s program provides low-cost loans and down payment assistance to a variety of education professionals. The program also offers a first-time homebuyer tax credit that allows school workers to claim up to $2,000 of their annual interest payments as a tax credit each year.

In 2016, San Francisco — the most expensive metro area in the country — began Teacher Next Door. The program gives a forgivable loan to educators working in the city’s school district who are first-time homebuyers. Also in California — where we found the nine least affordable housing districts in the U.S. — the Los Angeles Unified School District is repurposing public land to create three housing developments to ensure its staff has affordable rental housing. The district’s program is open to all of its direct staff.

What More Can Be Done?

Viveiros said the key is “creating communities that offer housing affordable at a number of different income levels and offering housing of different types” to present a mix of affordable price points.

Thinking as a community can help create solutions, Viveiros said. She recommends that parents and other community members “lend their voice to the need for affordable housing in their community” by attending and speaking up at zoning meetings.

 

 

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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How to Shop and Save on Closing Costs

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

New Home Closing Costs

Back in April my husband and I put in offer on what would be our first home, and — joy of all joys — it was accepted.  We were finally on our way to the last stage of the seemingly never-ending home buying process: closing.

If you’re like us, then by the time you’ve decided to plunk down six figures on a new home, closing costs might seem like a minor fee. But these fees can add thousands of dollars to the cost of your home. According to Zillow, closing costs generally cost 2-5% of your home’s purchase price. On a $200,000 home, that could mean forking over an extra $4,000 to $10,000. (If you’re lucky, you can negotiate for the seller to cover some of your costs, but it’s still a big chunk of change.)

What many people don’t realize is that not all closing fees are set in stone. You can shop around and find better deals if you so choose.

We’ll explain which fees you can shop for and how much you can save.

Closing Costs: The Basics

Although you typically pay your closing costs in one lump sum, you’re actually paying for several different fees. Those fees cover things like your real estate attorney fees, your appraisal, title insurance, and a pest inspection. Your lender is required to give you a list of your closing costs along with your loan estimate within three days of receiving your loan application. That list will contain all the services you need to pay for and the different vendors the lender has chosen to provide them.

Closing fees can sometimes be bundled into your mortgage loan, which can save you the trouble of coming up with the cash right away.

But if you’ve got time on your hands – and you’re willing to put in the effort —  you can shop around for some fees and save yourself several hundred dollars. Here are a few fees that you can shop for (this list will vary from lender to lender, but it’s a good place to start):

  • Title fees (including the Title Search, Title Insurance Binder, Title Settlement Agent Fee and the Lender’s Title Policy — although keep in mind that in many cases the seller actually covers some of these fees … more on that later)
  • The Pest Inspection Fee
  • The Survey Fee

If you decide to find your own vendors, you need to decide quickly — ideally, before you put in your offer. Title insurance items are especially tricky to shop for after your offer has been accepted by a seller because some lenders require that your realtor write those stipulations into the contract of your offer. If they aren’t written into your contract ahead of time, it’ll likely be too late to go back and say you want to do some cost comparing later.

States, and even individual counties, often have their own laws regarding closing cost fees and transactions. Ask your realtor, real estate attorney and/or mortgage broker about the laws where you live. First American Title, a leading provider of title insurance in the U.S., has a state-by-state guide of real estate laws and customs on its site, but it might be hard to understand the jargon without the help an expert.

As we mentioned before, your mortgage broker is required to give you a list of companies in your area that provide the services for which you’re shopping. Just remember that if you decide to shop around for a vendor not on the list, your lender needs to agree to work with your outside choice.

How to save on closing costs

Title documents

What it costs: Title items usually come as a bundle (including the Title Search, Title Insurance Binder, Title Settlement Agent Fee and the Lender’s Title Policy), and the national average is around $2,263.16 for the package, according to Closing.com, a premiere source for closing costs and service providers in the U.S. residential real estate industry.

How to shop for it: Confirm that whatever company you go with is a licensed title insurer in your state. A good starting place is throughThe American Land Title Association, where you can find reputable title service options in your area. Jeffrey Goldstein, a real estate attorney, recommends working with companies that work in every single state in the U.S. and are considered among the safest underwriters. A few of these companies include:

Is it worth it? It could be.

Title items are tricky since they come packaged as a bundle and, as mentioned above, often the seller covers some of the fees (this will be stipulated in your contract if it’s the case with your offer). Asking to shop around for outside offers may mean giving up your right to have the seller cover his or her portion, or it may make your overall offer less desirable altogether. You’ll need to verify with your realtor and lender the rules in your area, but if the seller and your lender are game to let you do some research, this is definitely where you could save the most money, since it’s one of the most expensive closing costs.

Pest Inspections

What it costs: The national average is $126.37, according to Closing.com.

How to shop for it: Pest inspections aren’t always required, but if they are or you’d just like one, finding a reliable pest inspector in your area probably won’t take much more than a quick Google or Angie’s List search. My search for good pest control companies in my area on Angie’s List is here — just replace Arvada with your hometown to find ones in your own neighborhood.

You can also try The National Pest Management Association to help point you in the right direction.

Is it worth it? This one may not be worth the time and effort. Prices are so low relative to other fees that you may not feel like you’re saving much.

Surveyors

What it costs: The national average is $587, according to Closing.com.

How to shop for it: Land surveyors help you understand where your property line is exactly. Sometimes a land survey is not even required in closing, but it might be. To find a good surveyor in your area, The National Society of Professional Surveyors is a good place to start. As an association of licensed professional surveyors with access to reliable surveyors all over the country, they can point you to some good sources in your own area to do your price comparing.

Is it worth it? Depending on where you live, it could be. In Alaska, for example, the average land survey costs about $1,400. In D.C., however, where the typical survey costs $185, it’s probably not worth the effort. Check with the NSPS to get an idea for what the typical survey costs in your area before doing the work.

Cheryl Lock
Cheryl Lock |

Cheryl Lock is a writer at MagnifyMoney. You can email Cheryl at cheryl@magnifymoney.com

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Mortgage

First-Time Homebuyer’s Guide

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Homebuyer’s Guide

Buying a home is one of the biggest and most important financial decisions you can ever make. When done properly, a home can be an excellent investment. Rent is just an expense that makes your landlord rich. A mortgage can help you build wealth over time as you build equity. And a home is more than just a financial investment. It can be a place to build a family and make wonderful memories.

But a home can also be a financial nightmare. If you buy more than you can afford, you can end up in serious financial difficulty. Being foreclosed doesn’t just destroy your credit. It is an emotional and psychological nightmare. If you move too often, the costs associated with buying and selling a home can actually make renting a better option. And if you fail to budget for maintenance, you might start resenting the “money pit” that your house has become. Far too many people feel like their home “owns them” instead of the other way around.

If you are thinking about buying your first home, this guide is for you. In this guide, we will help you answer:

  • Should you use a mortgage to buy a home right now?
  • How big should your down payment be?
  • What is required to get approved for a mortgage?
  • What type of mortgage should you use?
  • How do you shop for the best mortgage?
  • What do all of those closing documents actually mean?

Section 1: Is a Mortgage Right for Me?

You already know that buying a home is one of the biggest financial moves you’ll ever make. You don’t need a lecture about how much responsibility this is, or how a monthly mortgage payment can be a burden on your budget.

What you do need is a way to understand whether or not a mortgage is right for you and your financial situation. While the idea of homeownership is often sold to us as the ultimate manifestation of the American Dream, buying a home is not necessary for everyone — and certainly isn’t the savviest financial decision in every single case.

What Are the Pros and Cons of Buying a Home?

It may help to understand some of the biggest advantages and disadvantages of homeownership to determine if a mortgage is right for you:

Advantages of Homeownership

  • The principal and interest in your monthly mortgage payment will remain steady over time and won’t rise with inflation (if you have a fixed-rate mortgage).
  • You can build equity as you pay down your mortgage and your home (hopefully) increases in value over time.
  • You have the option of turning your home into an income-producing rental property, which gives you the opportunity to earn a higher return on your investment in the house.
  • You may be able to take advantage of tax breaks and credits.
  • You have a place to call your own and settle down, which is a huge advantage for many people who want to feel deeply connected to a community or to provide a stable, unchanging place to start and raise a family. It also gives you the opportunity to live 100% how you choose to do so; you’re not limited by condo association rules or the wishes of your landlord.

Disadvantages of Homeownership

  • While your principal and interest in your mortgage payment will remain steady, property taxes and homeowner’s insurance may not. Over time, both your insurance and taxes will likely increase.
  • There’s no guarantee that your home will rise in value, or that you’ll be able to use it as an investment. Even when homes do appreciate in value, it’s very slowly over time. A house will generally cost more than renting if you plan to buy and sell in 5 years or less.
  • Homes take up a lot of cash — from the down payment to the regular costs associated with maintaining them. This can be problematic, because cash is completely liquid. A home is an illiquid asset. Homeownership can create a lot of financial pressure.
  • You have limited flexibility. Selling a home can be a process, and your timeline for offloading property is at the mercy of the economy and the market. You also have increased responsibility. Not only do you have to pay for maintenance and repairs, but you have to manage every situation yourself. There’s no landlord to call when something goes wrong.
  • It takes a while to enjoy the financial benefits of a home. If you don’t stay in your home long enough, renting would likely be a better decision than buying:
    • In the first years of your mortgage, more than 60% of your monthly payment goes towards interest. In the last year of your mortgage, less than 5% of your payment goes towards interest. Don’t expect your mortgage balance to reduce much in the first years.
    • There are a lot of fees when you buy and sell a home. When you buy, closing costs can be between 2 and 5 percent of the purchase price. And when you sell, real estate fees can easily be 6 percent of the property value. To buy and sell a home, expect to spend 10 percent of the home’s value in fees alone. On a typical 30 year mortgage, it will take 5 years to pay off 10% of the mortgage balance.
Your Checklist for Determining Whether to Buy Now or Wait

Knowing the pros and cons is an important first step. There are downsides to every situation, and part of making decisions is accepting the negatives.

If you feel comfortable with the not-so-great parts of homeownership and are still leaning toward buying your first home, use this checklist to help you determine whether now is the best time — or if it’s smarter to wait.

You might be ready to take out a loan and buy your first home if you:

  • Understand your future plans and goals, and how a home fits into those.
  • Can rely on your income and know what to expect with your earnings from month to month and year to year.
  • Are ready to settle down in one location for at least 5 years.
  • Know how a mortgage works, and understand what your responsibilities and obligations for repayment are.
  • Have enough cash to make a down payment.
  • Have enough cash to cover the closing costs – which can be expensive. You can use this closing cost calculator to estimate.
  • Have enough cash to meet the “cash reserve” requirement of your lender. Depending upon the type of mortgage you have, you could need between 2-6 months of mortgage payments in the bank.
  • Maintain enough monthly cash flow to cover monthly mortgage payments and unexpected costs like emergency repairs and irregular maintenance.
  • Have enough money to cover the expected annual maintenance costs. On average, people spend between 1 and 4 percent of their home’s value every year on repairs replacement.
  • Have actually done the math to determine what’s cheaper: renting or buying. This excellent calculator from The New York Times can help you determine what’s financially best for your situation.
  • Are able to cover your current costs and living expenses without struggle each month, and have other debts under control (or are debt-free).
  • Know what you’re actually looking for in a home for the next 5 years.
  • Have done your due diligence, asked questions and received answers, and done research on what all homeownership entails.
  • You are financially ready to deal with the broken air conditioner one month after moving in!

If you’re not checking many of these boxes, homeownership isn’t out of the question for you. But it’s a smart idea to expand your goal’s timeline. You may need to save more money for a down payment, find a more stable job with reliable income, or decide what you really want your life to look like — and where you want to live it — before committing to borrowing money that will take you decades to repay.

You Have Other Options

If you discover that taking out a mortgage is not right for you, this is not a bad thing. There’s absolutely nothing wrong with this! And you should be proud of yourself for recognizing and honoring this decision.

Too many people feel pressured to buy a home, or leap into homeownership without fully understanding whether or not that’s the best route for their situation. Remember, it’s much easier to start this process and take out a mortgage than it is to sell your home, repay your loan, and walk away without losing a lot of cash if you suddenly realize buying a house was a mistake.

Homeownership isn’t the only good option available to you. In many areas and for many people, renting makes more sense both for the lifestyle they want and for their financial situation. A house isn’t cheap and requires constant maintenance and management in addition to that monthly mortgage payment. Renting is much less work for you as a tenant, allows for more mobility, and may be cheaper than owning.

Homeownership later, instead of right now, may be another option. Again, you can extend the time horizon on your goal. Perhaps instead of buying now, you can save for an additional 5 years to put yourself in a position to comfortably buy property and afford the ongoing costs associated with it.

This is a much better option than pushing your budget past its limit and finding yourself in a position where you cannot pay for the necessary maintenance or make your monthly mortgage payment.

The Bottom Line: Is a Mortgage Right for You?

Again, everyone’s financial situation — and everyone’s goals and dreams — are different. This is a highly individual decision and many factors feed into what’s best for you. That includes your current cash flow, your income stability, your location, and your future plans.

To determine if a mortgage is right for you at this time, ask yourself these questions:

  • Are you prepared to stay in one place for at least 5 years? Buying may not make much sense if you’re unsure of your future plans. If you know you want to stay put for 5 years or so, and can commit to that, you may be ready for your first home.
  • Is your job and income stable? There’s no getting around the fact that any home is prone to eat up your cash and a large part of your monthly cash flow. If your source of income (for most of us, that’s our job) and the amount of income you make is stable, you may be in a good position to buy. If your income is unpredictable or you don’t feel secure in your current job, focus on stabilizing these factors before taking out a mortgage.
  • Do you actually want to buy a home? Get honest with yourself. Are you interested in buying your first home because that’s what you want — or are you feeling pressure from friends, family, or society as a whole? Make this decision for yourself. Not for anyone else, and not because it’s something you’re “supposed” to do.
  • Do you have enough cash to get through the first year? The first year is always the most difficult. It will almost certainly cost more than you budget. If you are going to be broke after you move in, you are not ready for a house.

If a mortgage is right for you, read on! Your work isn’t quite done. You still need to understand the ins and outs of down payments, how to get approved, what kind of mortgage you need, and understanding all the costs involved with buying your first home.

Section 2: Saving Up for Down Payments

If you’re still on board to buy your first home and you know taking out a mortgage is right for you, you need to understand how to save up for the right down payment — and why it’s so important that you do so.

The general rule of thumb is to put at least 20% of a home’s purchase price in cash down when you take out a mortgage. This means you’re financing 80% of the purchase. And remember: you will need cash for the closing costs in addition to the down payment.

And yes, 20% of a home’s purchase price is a lot of cash to put down and part with all at once. The median price of a home in the US was $221,800 in 2010 (the latest year data is available from the US Census). A 20% down payment would be almost $45,000 in cash!

Of course, this number varies wildly depending on one major factor: location. A home in Pittsburgh will be a lot cheaper than a home in San Francisco. But whether you’re looking at buying a $100,000 home and need to save $20,000 to put down or want to buy a $500,000 property and need to come up with $100,000 just for the down payment, we’re talking about a big chunk of change.

Why is this 20% number so important — and more importantly, how do you save up for it?

Why Is 20% So Important?

So why bother saving up that much money in the first place? After all, lenders will finance more than 80% of a home’s purchase price. Some loans will let you put down as little as 3.5%. Why pony up all that cash if you don’t have to?

There are a few major reasons why it’s worth making the effort to save up the full 20% for your down payment:

  • Saving up 20% for your down payment allows you to avoid PMI. PMI stands for private mortgage insurance, and you must pay this additional fee if you put down less than 20%. The idea behind it is that financing more than 80% of the home’s purchase price means you’re a riskier borrower for the lender. They impose PMI to protect themselves in case you default on your mortgage. PMI can add anywhere from $50 to $300 more onto your monthly mortgage payment, depending on the home price and your specific home loan.
  • Putting more cash down means more equity in your home right away. This can help protect you during market downturns or when home values sink. You’re less likely to find yourself underwater (owing more on your home than the house is actually worth).
    Remember: when you sell your home you will probably need to pay 6% of the home’s value in fees alone. The more equity you have, the more flexibility to get out of the situation if you are in trouble.
  • You save money on your home over the life of the loan. Financing less of the purchase means borrowing less money — and that means paying less interest on those borrowed funds. This can add up to serious savings, when you consider that home loans can cover hundreds of thousands of dollars.
  • Your monthly mortgage payment is smaller. It’s simple: if you borrow less, there’s less money to repay. The principal amount that you need to pay back each month will be smaller, making your entire payment less than if you borrowed a larger amount.
  • More cash up front can be used as a bargaining chip in the buying process. If you’re in a competitive market where multiple buyers put offers in on one home, putting down more cash may make you more appealing to the seller.
How to Save for a Home Down Payment

The short answer to “how do I save for a down payment?” is: set a goal, create a plan, spend less, and save more. There’s no magic solution. It really is that simple — but that doesn’t mean that it’s easy. You may need to cut costs out of your budget and make some sacrifices to free up more cash that you can allocate to your first-time home buying fund.

Here are some other steps you can take to save up for the down payment you need:

  • Reduce your expenses now. Move to a place with cheaper rent for a few years, embrace living frugally, cut back on discretionary spending, and get clear on your values and your priorities. Again, saving up enough for what you really want may be a long, hard slog. It’s important to remember why you’re working this hard: for the home you really want. Put in that perspective, living on less now so you can get into the home you want in the future is well worth the effort.
  • Reduce your price point. Make saving up for a down payment easier by looking for cheaper homes. You may need to consider buying less house or looking in lower-cost areas.
  • Boost your savings — and your income. Don’t just focus on how you can save more in your current budget. Look at how you can earn more, too. Earn and negotiate a raise, consider picking up more hours or part-time work, or explore creating an income stream based off freelance work or a side business.
  • Put your savings to work. If you have a long time horizon before you want to buy (say, at least 5 years out), consider moving your cash savings into a brokerage account and investing that money. All investment comes with risk, but with a large enough time horizon you’ll give yourself the opportunity to ride out market volatility. And your savings could earn far more than the piddling 0.01% interest rate that a liquid savings account.
  • Get the right savings account. If investing isn’t right for you because you want to buy sooner rather than later, make sure your cash is in a savings account that offers at least a little something. Credit unions may have high-yield savings accounts, or check out various online banks. Shop around and choose an account with the highest yield.
What Not to Do with Your Savings

There are also a few things you shouldn’t do to save for a down payment. The biggest: don’t drain your retirement accounts in order to buy your home. While you can do this — sometimes without penalty for dipping into your nest egg — it’s not a wise financial move.

It makes no sense to jeopardize your future financial security in exchange for buying a home right now. You have so many more options to explore first (like continuing to rent, buying in 5 years instead of 2, and so on). Avoid cashing out your 401(k) or Roth IRA for your down payment.

You’ll also want to avoid borrowing money just to take out a mortgage. Not only will you have to repay that original loan, but you’ll also need to start making monthly mortgage payments right away. Not to mention, most lenders won’t allow you to do this.

If you plan on using gifts for your down payment, you need to do your homework. In general, lenders will only accept gifts from family members. If you are putting down 20% or more, most family gifts are acceptable. If you put down less than 20%, your lender might put certain restrictions on allowable gifts. Just make sure you have a lot of documentation for any gift received, and be prepared to explain it.

What to Do If You Can’t Make a 20% Down Payment

A 20% down payment is the ideal number to shoot for, for a number of reasons. But let’s be honest: that’s a big sum of money that’s not always realistic to expect first-time homebuyers to save. You can buy a home and take out a mortgage if you have less than 20% of the home’s purchase price to put down in cash.

Kali’s Story:

When I bought my first home, I put only 10% down in cash — and even that wiped out my cash reserves. It took me about a year to build my savings back up, and I was extremely lucky that I got through that time period without any unexpected expenses or emergencies to handle. And because I put down less than 20%, I had to pay PMI. That added about $50 to my monthly payment that I wouldn’t need to pay had I financed less of the purchase.

In my situation, putting down less and getting into the home worked out in the end. Several factors contributed to that success: I bought the property when the market was still depressed, I bought a relatively inexpensive home, and I bought a home with resale opportunity at the forefront of my mind. I wasn’t looking for a dream home — I only wanted something I thought would be easy to quickly sell in a few years.

Had I waited to save 20%, the market would have shifted making inventory more expensive. The economy would have continued to recover, meaning interest rates on mortgages would have risen above the very low 3% I secured on my loan. And I wouldn’t have been able to cash in on my initial investment when I did; I may not have been able to sell my home within 3 years for a profit.

Is it possible to buy a home and get a mortgage if you put down less than 20%? Yes. Is it the wisest financial move? Probably not if it puts you in a precarious situation. Before choosing to use a smaller percentage, you need to understand the implications of putting down less in cash.

You have less equity in your home and it will take you longer to build that equity. You’ll pay more all around: more each month in your mortgage payment, more in interest over the life of your loan, and more thanks to PMI.

If you choose to buy a home and take out a mortgage with a smaller down payment, here are a few things to keep in mind:

  • Know that you’ll pay more. Be sure to understand the math for your specific situation: calculate how much you’ll pay if you put down 20%, and how much you’ll pay with a smaller down payment. The difference in costs may be acceptable to you, but you can’t make that decision until you’re fully aware of the actual numbers involved either way.
  • Don’t pour all your cash reserves into a down payment. Even a 10% down payment may be a stretch for you. But ensure that regardless of what amount you put down on the purchase, you still have some cash in the bank. Taking on a mortgage (and the home itself) means taking on more financial responsibility, and that requires you to maintain an emergency fund to cover the unexpected. Many lenders will even require that you have extra cash in the bank (cash reserves).
  • Look into various types of mortgages. The specific type of mortgage you’ll take out should be based on your financial situation, how much you want to put down, and how long you want to live in your home. FHA loans allow you to put down as little as 3%, but come with fees and additional costs that may not make sense for you. Consider working with a financial planner to figure out all your options, and to choose what’s best.

Section 3: How to Get Approved for a Mortgage

You’ve decided you want to buy a home. You know you’re ready to take on a mortgage. Now you need to determine what you can afford — and get yourself approved for the loan you want. Lenders assess you by factors like your debt-to-income ratio, income, assets, employment history, down payment, and credit history.

Here’s what that all means.

Understand What You Can Actually Afford

Before you can understand how these factors in your unique financial situation measure up from a lender’s perspective, you need to get clear on what you can actually afford, and how much money you’ll ask to borrow.

Lenders are legally required to only make loans that borrowers can reasonably afford to repay. But the definition of what you can reasonably afford may still be different than what you can realistically afford when you consider paying for unexpected expenses, managing other debts like student loans, and saving for retirement.

There are general rules that say your housing costs shouldn’t exceed about 36% of your income. That means, if you make $60,000 per year the total amount you spend on your home shouldn’t be more than $1,800.

But that’s a lot of money when you consider you still have a variety of other expenses to cover — and you don’t want to put so much stress on your budget that you’re unable to save cash, invest for the future, or cover one-time costs that pop up from time to time.

Loan calculators can be helpful tools to help you determine what you can realistically afford to purchase.

To fully understand the baseline costs you’ll pay, do your research. Know what the property tax rate is on homes in the county or town in which you want to buy. Call insurance companies and get quotes on policies. Look up the current average interest rate on mortgage loans.

Then take all that information and plug it into a loan calculator to get a more realistic idea of what the monthly payment would look like on homes in the price range you want to start in. If the payment is excessive, it’s time to lower your price point.

And if you feel comfortable with the estimated payment, that’s great! It doesn’t mean that’s the green light to spend more. Your mortgage payment should fall well within your means. Life is unpredictable and you may face higher expenses in the future. You could lose a job and find it hard to generate income — or you could start a family and see more of your monthly cash flow going to the needs of your children.

Whether positive or negative, you’re bound to experience changes in what’s available in your monthly budget over the years you own your home. Aim to leave wiggle room in your budget, and don’t think that you should max out what you can afford just to get “more” house.

What Lenders Look for in Borrowers

Once you understand what you can realistically afford in your monthly mortgage payment, you can consider what a lender is looking for before they’ll approve you for that home loan.

Lenders will want to ensure that you are willing and able to pay. Here is how lenders measure willingness and ability:

  • Your FICO credit score helps lenders see how willing you are to make payments on time. If you made payments on time in the past, it is highly likely that you will make your payments on time in the future.
  • Your ability to pay is measured by your down payment, debt burden (debt-to-income) and cash reserves. Lenders will want to verify all of this information.

Your credit score is a critical factor in getting approved for a mortgage. Lenders pull a hard inquiry to look at your FICO score, which determines how much of a risk you present to them. A lower credit score indicates more risk, and as a result, you won’t be able to secure as low of an interest rate as someone with a higher credit score (who is deemed less risky).

Lenders will want to look at all the assets you have, from cash to investments, and they’ll want to understand how much debt you currently carry. Looking at your income and assets allows the lender to get an idea of what you can afford and what reserves you have to pull from should something interrupt your cash flow.

They also want to understand how much debt you already have. Together, they’ll look at these numbers and determine what your debt-to-income ratio is. This ratio helps the lender determine how much money they’ll allow you to borrow.

Your DTI ratio should be under 36%. The lower your ratio, the better you look to the lender and the more likely you’ll get the mortgage and interest rate you want.

But before approving you for any mortgage, a lender will want to look at how reliable your income is. There’s no hard measure for this, but typically the institution will want to know about past and present employment.

If you’ve only be at your current job for a few months, that might make it harder to qualify for a mortgage. To the lender, the reliability of that source of income isn’t proven because you’ve only been earning it for a short period of time.

Your down payment impacts how lenders view you as a borrower, too. A smaller down payment signals more risk for them. A larger down payment makes it easier to secure the mortgage you’re looking for.

Better Your Chances and Get Proactive

Use this checklist as a guide to the action steps you can take before you talk to any lenders:

  • Prove that you’ve been employed and have consistent, steady income. You will need to provide proof of your income, typically via a payslip (for your most recent salary) and W2 (for historic payments). Ideally, you will have at least 2 or more years of steady income with your current employer. New to your current position? Consider pushing out the timeline for buying a home a bit. While it’s not fun to delay a goal, it can make the process considerably easier and may save you money if you’re able to show reliable income and therefore get a lower interest rate on the loan. And if you’re self-employed? Be sure to read Section 6 of this guide!
  • Pay down other debts. Improve your debt to income ratio by paying down any balances on credit cards, student loans, or other debts. This will improve your chances of getting approved, and better your overall financial health.
  • Save up for an appropriate down payment. Remember, 20% is ideal. However, you may be able to get a good mortgage with 10% down — and FHA loans only require a 3.5% down payment. While you can get by with less, a bigger down payment makes it more likely that you’ll get approved for exactly what you want.
Understanding the Importance of Your Credit Score

You may not be able to magically make thousands of more dollars per month overnight to make it easier to buy a home and get a mortgage. But you don’t have to take drastic actions across all areas of your personal finances. Just focusing on your credit score can make a world of difference.

First, pull your credit report from AnnualCreditReport.com. You can get a copy of this for free on an annual basis. Your report covers your accounts and credit history, and it’s important to check it to ensure accuracy.

If you find an error, report it to one of the three credit bureaus: TransUnion, Equifax, or Experian. We explain how to dispute credit report errors in this article.

Note that your credit report won’t include your actual credit score — and know that you don’t actually have just one score. Each of the credit bureaus issues you a score based on their own algorithms. And you have what’s known as a FICO score. That’s the one a lender will evaluate to determine your creditworthiness when you apply for any type of loan, including a mortgage.

For a mortgage, your official FICO score is very important. There are a few ways to get your official FICO for free. You might have a credit card that provides your score for free. If not, Discover offers free FICO scores to everyone (you do not have to be a Discover customer). We explain how to get your FICO score for free here.

Credit scores run from 300 to 850, with 850 being considered the absolute best. To get the best mortgage rates, you would want your score to be above 750. And you might find it very difficult (and more expensive) to get a mortgage when your score is below 640.

What to Do About Your Credit Score

A poor credit score won’t prevent you from getting a mortgage at all, though it may make it harder to qualify and cost you more. Your loan can also cost you more over time, since you won’t be able to get the lowest available interest rate. It’s well worth taking the time to work on your credit score before seeking approval for a mortgage.

Even if your credit score is considered good, work to boost it over 750 and have it considered excellent by lenders. Again, the higher your score the better your interest rate — and the more money you’ll save on interest. If you want to know how a better credit score could pay off, check out this tool that shows you the mortgage rate you could receive based on your score.

Here are some steps to take:

  • Make all credit card, account, and loan payments on time and in full.
  • Don’t carry balances on your credit cards.
  • Avoid opening or closing new lines of credit.
  • Keep your credit utilization ratio low. This means using as little of your available credit as possible. To have the best score, your utilization should be below 10%.

Keep in mind that improvements to your score won’t happen overnight. It may take a few months or over a year to get your score into that good range, depending on where you’re starting. Stick with it and keep your actions consistent.

What Hurts Your Chances of Getting Approved?

It’s important to note that some actions that you might otherwise think are innocuous can hurt your chances of getting approved for a mortgage. Here’s what you should avoid in the weeks and months before you approach a lender about a home loan:

  • Don’t take out new loans. If you want to secure a mortgage, remember that your DTI ratio plays a big role in what you qualify for. Avoid taking on new debts (including co-signing loans for others!).
  • Don’t open new credit accounts. This can impact your credit score and affect the interest rate you can receive on a mortgage.
  • Don’t generate any unnecessary banking activity. All of your accounts will be closely scrutinized in the approval process. Any activity without clear explanation can be questioned and the lender can require that you provide documentation to show why and how money moved in or out of your accounts.
Don’t Just Get Approved: Get Pre-Approved

One last important thing to note about mortgages and getting approved: you can — and should — get pre-approved. This simply means that you approach a lender before you start looking for homes and putting in offers on properties for sale.

The lender will take a cursory look at things like your credit score, income, debt, and employment history. The lender can then make a good faith guarantee that they can grant you a loan up to a certain amount when you actually find a home to buy and want to take out a mortgage to purchase the property.

This will get you a quote on an interest rate, but more importantly for your home search, will allow you to put in offers on homes you’re interested in. Many buyers will not even accept offers from buyers who have not been pre-approved. It’s a simple step that can make a big difference in your homebuying experience.

Section 4: Choosing a Mortgage Type

All mortgages are not created equal. There are a number of different types of loans that can help you purchase your first home depending on your situation, your down payment, and other qualifying factors.

Here’s a quick rundown of your options when it comes to choosing a mortgage:

  • Conventional
  • FHA
  • VA
  • Jumbo loan
  • Fixed rate or adjustable rate
  • 15 year or 30 year term

Let’s dive into the details on each of these distinctions:

How Conventional Loans Work

Fannie Mae and Freddie Mac are two quasi-government agencies that purchase mortgages from banks and mortgage lenders. These agencies set rules for what they will buy. If a mortgage meets the rules of Fannie and Freddie, it is considered “conventional.”

Conventional mortgages follow standard guidelines and don’t come with many bells and whistles — which means there are less hoops to jump through to qualify for these loans. They often close faster and offer an overall easier process for borrowers to work through.

You also have more options when it comes to the actual property you’re looking to buy. If you’re handy and want to take on a fixer-upper, for example, lenders will allow you to buy the property you want with a conventional loan. The same is true if you’re looking to buy anything other than a single family home, like a condo. Other loans have strict requirements on the condition of the property you want to buy, which can limit your options.

A 30 year conventional loan is most likely your best bet if you’re a conventional borrower: good credit score, low debt-to-income ratio, 20% down payment. If you can check all these boxes, you’ll likely get a competitive interest rate on a mortgage with few restrictions or requirements.

You may struggle to qualify if you don’t mean the traditional guidelines for lenders, however. And that’s where other mortgage products come into play.

What You Need to Know About FHA Loans

FHA loans are mortgages insured by the Federal Housing Administration (FHA). FHA loans can offer first time home buyers more options than conventional loans, as they don’t come with as many restrictions and offer more exceptions. Both of these factors can make buying a home much easier for you.

In general, FHA loans allow lower credit scores, higher debt burdens and lower down payments. But, in exchange, the loans cost more.

FHA loans only require a down payment of 3.5%. Why? Because of that insurance from the FHA. Lenders are more willing to originate loans for borrowers they’d otherwise consider risky, because if that borrower defaults the FHA promises to repay the loan.

So what’s the catch? The cost for an FHA loan can add up fast, thanks to various fees you need to pay as the borrower. The FHA doesn’t insure these loans out of the goodness of its heart. You’ll pay more for fewer restrictions and the ability to put down less over the lifetime of the loan.

The insurance fee is 1.75% at the time of the loan origination. You’ll also pay an ongoing monthly fee of 0.85% if the loan-to-value ratio is more than 95.01%. (And your 3.5% down payment would place you in this category.) This isn’t the same as PMI, which can eventually be removed once you build a certain amount of equity in your home. The insurance on FHA loans remains for the entire term.

That doesn’t mean an FHA loan is never a good option. If you have a poor credit score or simply cannot put more than 5% to 10% down, it’s worth exploring this type of mortgage to help you buy your first home.

Other Mortgage Options

In addition to conventional and FHA loans, borrowers may also be able to take out other types of loans. These include:

  • VA home loans. VA stands for Veteran’s Administration, and it’s a branch of the Federal government that helps servicemembers and veterans along with their eligible family members. The VA offers various housing programs to help vets “buy, build, repair, retain, or adapt a home.” The VA’s home loans are originated by private lenders, but the VA guarantees a portion of the loan. This allows the private lender to make the loan with more favorable terms than they might otherwise offer.
  • Jumbo loans. Fannie Mae sets what are known as “conforming loan limits” that lenders of mortgages cannot exceed. In plain English, this means that lenders cannot give you a conventional loans in excess of $417,000 on a single family home (at. This isn’t an issue for most, but if you live in a high-value real estate area and homes easily sell for over $500,000, have a strong credit score, and a low debt-to-income ratio, you may want to look into a jumbo loan. Jumbo loans allow you to borrow more than the conforming loan limit. But they are expensive loans to originate, many lenders will not make them, and you’ll have to jump through a number of hoops to qualify.
Fixed Rate vs. Adjustable Rate Mortgages

Loans come with various types of interest rates and terms. The actual interest rate can fluctuate based on a lender’s assessment of your creditworthiness, but you can also choose between a fixed rate or a variety of adjustable rates.

Fixed rate mortgages mean that you have a set interest rate that never changes over the life of your loan. If you take out a fixed rate mortgage with a 4% interest rate, you’ll always pay 4% in interest. (Note: we are very lucky in the USA. Most people around the world do not have access to 30 year fixed rate mortgages. Being able to borrow for 30 years at a low fixed interest rate is a great deal).

The benefit of this type of mortgage is that there are no surprises. You always know what you owe in interest, and your rate will never go up. This means that the rate isn’t subject to the economy or inflation. A fixed rate mortgage may not provide the absolute lowest interest rate available, and that’s where ARMs come in.

Adjustable rate mortgages are also known as ARMs. As the name suggests, the interest rate will adjust, or change, over the life of the loan depending on the specific terms of your mortgage. The rate remains fixed for 5, 7 or 10 years. Then the interest rate become adjustable, subject to change each year.

Many borrowers can secure a lower interest rate in the initial years of the loan if they choose an adjustable rate. However, that interest rate usually skyrockets as soon as the adjustable period kicks in. This can cost you far, far more over the life of the loan. And your payments will eventually be subject to external factors outside of your control.

ARMs aren’t always bad (although we usually recommend a 30-year fixed rate). If you are making a big down payment and only plan on being in your home fewer than 10 years, an ARM could be a good deal. You will end up paying less interest while you live in the home and then sell.

ARMs are a terrible idea if you can’t afford the payment when the interest rate is fixed. If your plan is to take out an ARM now (at a lower payment) and then refinance before the payment increases – you are setting yourself up for failure. Stay away.

In general, you should try for a 30 or 15 year fixed rate mortgage. Interest rates are at an all-time low and will only go up. You have the chance to lock in low interest rates now.

What’s Term Got to Do with It?

Most mortgages will come in either 15 or 30 year terms, meaning you either have 15 or 30 years to repay the loan. Most borrowers will choose a 30 year term because the longer repayment period equates to lower monthly payments.

A 15 year mortgage obviously allows you to repay your loan in half the time. That means you’ll save money in interest payments, build equity faster, and own your home free and clear in 15 years instead of 30.

If you’re interested in paying off your mortgage as quickly as possible, a 15 year loan may sound much more appealing than stretching that repayment over double the amount of time. But the best solution may be to choose a 30 year mortgage that allows for early payments without penalty.

You’re only required to make the monthly mortgage payment, but you can get on track to paying off your loan in half the time by doubling the amount you pay each month or making multiple payments toward your principal each month, instead of just one. This removes the pressure to make massive monthly payments: it’s now a choice, rather than a requirement, which provides you with more flexibility in your monthly cash flow.

Warning: People often refinance their mortgages. Refinancing can be a good option, particularly if you can get a lower interest rate. For example, if your credit score improves and the value of your property increases (reducing the LTV), you might be able to get a much lower interest rate than when you opened the mortgage. Just make sure you don’t fall into a common trap of extending your term when you refinance. If you take out a 30 year mortgage and then refinance after 5 years into another 30 year mortgage, you have just extended the term by 5 years.

Section 5: Getting a Mortgage When You’re Self Employed

All of the previous sections have walked through ideas, advice, information, and details that apply to almost everyone looking to buy their first home and take out a mortgage. But if you’re self-employed, you need to understand that this process is unlikely to be as easy for you as it will be for someone with an employers.

The current system skews toward favoring workers who make W2 income. Why? Most likely because it’s much easier to prove stable income from legitimate sources, thanks to a steady stream of consistent pay stubs. When you’re self-employed, you only have your own records of your income from month to month and what you earn is variable.

If you run a business with overhead, your business expenses could also hurt you. Deducting costs can help you on your taxes, but it can hurt on your mortgage application. Lenders don’t look at your gross self-employment income. They consider your net, and that means they subtract business expenses from your income when considering these factors for a loan.

Before you panic, it’s not impossible to qualify for a mortgage when you’re self-employed. The system does seem to favor employed individuals, but there’s no reason you can’t secure a loan when working for yourself. You need to understand that it may be more difficult, and know what the lender will want to see if you apply while self-employed.

How to Prove Your Income

Gather your tax returns. Because you don’t have pay stubs from an employer, a lender will want to see tax returns for the past two years. Lenders request this information directly from the IRS, so they’ll ask you to fill out IRS Form 4506-T. That gives the IRS to release your returns to a third party.

If you haven’t filed your tax return from the most recent year, you can work with a CPA and ask for an audited profit/loss statement. You may also want to supply your business license or a an official statement from your CPA that says you’ve been self-employed for at least two years.

Beyond this change, you’ll need to provide the same information as other, employed borrowers do when applying for a mortgage: your bank statements, statements from investment accounts to prove your assets, and so on.

Bring Backup Documentation

If you’re self-employed, you know that your finances are rarely ever simple and straightforward. You may experience busy and slow seasons, spikes in earnings thanks to an influx of new clients or dips in your earnings because you took time off, and more. Countless things impact what you take home at the end of each month.

Lenders, however, work very linerally, and must adhere to certain guidelines when underwriting loans. While they can’t bend the rules to make the reality of your self-employment income fit into the qualification standards, they may accept additional documentation if it helps prove that you can reasonably afford to repay the money you ask to borrow.

When I bought my second house, I was in an interesting employment situation. In 2013, I started earning self-employment income on the side of my work as a W2 employee. In 2014, I quit my job and became self-employed full-time. I made more running my own business than I ever did as an employee.

In 2015, I took on a new position and once again became a W2 employee. I continued working on my own business on the side, however, and once again brought in both W2 income and money earned from self-employment.

Throughout this time, I consistently earned higher and higher incomes. In fact, my self-employment income alone was triple what I had made at my old day job that I quit back in 2014.

In the spring of 2015, I planned to sell my first house and buy a new home. But at the time I applied for a mortgage, my most recent tax return was from 2013 — and reflected the low income I made at a job I had since left. I hadn’t yet filed my 2014 taxes, and had just started the new job where I earned W2 income.

It was a complicated situation, and despite the fact that my cash flow and bank accounts supported my claim that I could afford to repay the money I wanted to borrow — and the fact that I had no debt — the lender was extremely cautious because the paper trail they like to see simply wasn’t there.

I did end up getting approved for the mortgage, but it took a lot of work. What made the difference was submitting all the documentation I could get my hands on to prove my income and show that I wasn’t an extremely risky borrower.

I wrote a letter of explanation walking the lender through my employment situation, submitted all my financial statements around my self-employment records of income and expenses, provided over a years’ worth of bank and investment account statements, and obtained a signed letter from my new employer stating their intent to retain me (and therefore, pay me a salary) for the foreseeable future.

It was enough to get approved for the mortgage, although the loan was contingent upon the sale of my first house. If you’re self-employed or are dealing with a situation that may look a little funny on paper (like all my changes in employment status), plan to bring backup documentation.

Prove everything you can with a paper trail, and ask the lender if they’ll accept letters of explanation from you and other relevant parties (like a new employer).

Section 6: Understanding ALL the Fees

When you take out a mortgage, there will be a number of costs associated with the mortgage. In particular, you will be expected to pay for:

  • Origination charges
  • Title insurance
  • Inspection fees
  • Other misc. Fees

In addition, you will be required to fund the escrow account and prepay certain items.

You will be given all of this information at least 3 days before your closing in a document. You can learn all about the disclosure, and how to read it, at the CFPB website.

Section 7: How and Where to Shop Around

To determine the best interest rate available for your credit profile, use the Interest Rate tool of the CFPB. With this tool, you can see the best interest rate in your market.

In general:

  • If you are going to get a conventional loan, you should just go directly to the bank or credit union that offers the best rate in your area. Paying for a broker is almost always a waste of money for conforming, conventional loans.
  • If you have a lower credit score or want to make a lower down payment, you might want to search for an FHA lender and go directly to them. Otherwise, a broker could be helpful if you have a more complicated situation. Just make sure that if you use a broker, you do not let the broker talk you into buying a home you can’t afford. Remember: the more you borrow, the more the broker will get paid.
Kali Hawlk
Kali Hawlk |

Kali Hawlk is a writer at MagnifyMoney. You can email Kali at Kali@magnifymoney.com

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Mortgage

The Guide to Getting a Mortgage After Foreclosure

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

mortgage after foreclosure

Introduction

If you’re among the one million homeowners who lost a home to foreclosure between 2007 and 2008, you may be starting to think about re-entering the housing market. If you went through a foreclosure during the earlier part of the financial crisis, it may no longer be on your credit report, and you may be qualified to try and become a homebuyer again.

If you lost your home more recently, along with five million other Americans between 2007 and 2014, it’s never too early to start preparing yourself for the qualification process. The three major credit reporting firms, Equifax, Experian, and TransUnion, begin reporting your foreclosure once a lender says you have missed your first payment, and you will have to wait seven years before it is removed. However, there are a variety of different mortgage options available, with varying eligibility requirements, and some have shorter waiting periods that you may be able to take advantage of if you qualify.

Here’s everything you need to know about qualifying for a mortgage after foreclosure.

What Will it Take To Get Approved?

Federal Housing Administration (FHA) Loans

Insured by the federal government, Federal Housing Administration (FHA) backed loans are often one of the first options foreclosed-upon borrowers turn to. Although bigger banks like JP Morgan Chase and Bank of America have restricted FHA loans by requiring very high credit scores, smaller banks have been more willing to lend to foreclosed-upon borrowers.

If you’ve gone through a full foreclosure and repaired your credit, you may be eligible for an FHA loan in just three years. Some borrowers have even been approved in as little as one year, although this is rare. According to Moody’s Analytics, about 1.2 million foreclosed-upon borrowers were approved for FHA loans after three years.

FHA loan programs vary from state to state, but they share common eligibility qualifications—minimum credit scores of 500-580 and a debt-to-income ratio of less than 43%. Plus, you’re required to make a minimum 3.5% down payment.

Although FHA loans require significantly lower down payments and look for lower credit scores than conventional mortgages, most loans are insured by mortgage insurance premiums, which will increase your monthly mortgage payment. Mortgage insurance premiums for 30-year mortgages cost 0.85% of the loan’s value, which adds up quickly for more expensive homes. And some homeowners are required to pay mortgage insurance premiums for the life of the loan. That’s why it’s important to carefully assess the full cost of your FHA mortgage.

FHA’s Back to Work – Extenuating Circumstances Mortgage Loan Program

Normally, you have to wait 3 years after foreclosure to be approved for an FHA fixed-rate mortgage. However, FHA’s Back to Work Program may help you qualify for a new mortgage in as little as one year after bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale. The program, which has been extended through September 30, 2016, offers families affected by the housing crisis and recession a second chance at homeownership.

How can you qualify? FHA will consider your eligibility if you’ve had a foreclosure but now meet the following criteria:

  1. You meet FHA loan requirements.
  2. You can document your foreclosure resulted from a financial hardship beyond your control.
  3. You have re-established a responsible credit history.
  4. You have completed HUD-approved housing counseling.

To begin the process, you will need to take a “Pre-Purchase Counseling” course with a HUD-approved housing counseling agency 30 days prior to filling out an application. You will also need to meet FHA’s loan requirements with minimum credit scores of 500-580 and a debt-to-income ratio of less than 43%.

Once a lender has determined you meet FHA’s requirements, you will be able to apply for a loan under the Back to Work program. You will need to explain how your financial hardship was caused by factors beyond your control — a reduction in income, job loss, or a combination of the two. These events need to have caused your household income to drop by 20% or more for a period of at least six months. Detailed documentation, like employment verification, W-2s, and tax returns, will be required to prove these events in order to qualify. Divorce, previous loan modifications, or the inability to rent an income property won’t count.

To re-establish a responsible credit history, FHA requires that you have 12 months of on-time rent payments. They also require that you haven’t been more than 30 days late on more than one non-housing loan payment. They also watch for collections accounts and court records reporting (with exceptions for medical bills and identity theft).

Fannie Mae Loans

Fannie Mae-backed loans have longer waiting periods for foreclosed-upon borrowers than FHA. The standard waiting period is seven years. However, extenuating circumstances may qualify you for three years.

Fannie Mae defines extenuating circumstances as “nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.” You will need to be prepared to provide your loan officer with an “extenuating circumstances letter” explaining why you had no reasonable alternatives other than defaulting on your financial obligations.

Fannie Mae requires a minimum credit score of 620 for fixed rate mortgages and 640 for adjustable rate mortgages. And they won’t accept a debt-to-income ratio of more than 43%. Fannie Mae loans require a 20% down payment.

Freddie Mac Loans

Similar to Fannie Mae loans, Freddie Mac also has a seven-year standard waiting period. Their waiting period for borrowers with extenuating circumstances is also three years.

In order to qualify as a borrower with extenuating circumstances, Freddie Mac requires your mortgage file to contain:
  • A written statement about the cause of your financial difficulties to explain the outside factors beyond your control.
  • Third-party documentation confirming the events detailed in your statement were an isolated occurrence, significantly reduced your income and/or increased expenses, and rendered you unable to repay your mortgage.
  • Evidence on your credit report and other documentation in the mortgage file of the length of time since completion of your foreclosure to the date of application and of completion the recovery time period requirements.

Freddie Mac also requires a minimum credit score of 620. They won’t lend if your debt-to-income ratio is above 43%. Freddie Mac loans require a 20% down payment.

Veterans Affairs (VA) Loans

Did you know 1 in 3 home-buying Veterans doesn’t realize they have a home-buying benefit? Depending on your length of service, duty status, and character of service, you may be eligible for a Veterans Affairs (VA) home loan after foreclosure. VA loans, guaranteed by the Department of Veterans Affairs, allow veterans and active military to bounce back more quickly after a foreclosure. The waiting period to be approved for a VA loan after foreclosure is only two years.

Once you have established you’re eligible, you will need a Certificate of Eligibility (COE) for your lender. This certificate will verify your eligibility for a VA-backed loan.

Veterans Affairs doesn’t limit the amount you can borrow. However, there is a limit to how much liability they are willing to assume, and this will affect the amount of money you can be approved for. Veterans Affairs’ liability is limited to the amount a qualified Veteran with full entitlement can borrow without making a down payment. Remember, these loan limits will vary by county, depending on the value of the home you are interested in.

If your income and credit qualifies, lenders will generally loan up to four times your entitlement without a down payment. Basic entitlements are usually $36,000 for eligible veterans. Although VA loans are more lenient on credit history than conventional loans, lenders generally look for a credit score of at least 620.

Non-Qualified (non-QM) Loans

For foreclosed-upon borrowers who don’t fit the standards for mortgages from Fannie Mae or Freddie Mac lenders, another product has emerged — non-qualified (non-QM) loans. These are a newer type of agency-alternative loan backed by hedge funds and private equity firms. The layers of risk associated with these loans are often secured by larger down payments or higher interest rates. The lender’s primary concern is your ability to repay, and many don’t require a waiting period for foreclosed-upon borrowers.

Ability-to-repay is an important aspect of qualifying for a non-QM loan, so most lenders will require income documentation. Depending on how much time has passed since your foreclosure, most loans require at least 20% down and adequate assets to cover reserves. You’ll find these interest rates are significantly higher than market rates.

A&D Mortgage, a private lender based in Hollywood, FL, offers non-QM products to foreclosed-upon buyers in their home state. They advertise that if there hasn’t been a judgement, you can apply for a mortgage as soon as you have settled your foreclosure.

Their loan periods are typically 24-60 months, with 7.999-11% adjustable interest rates. Down payments start from 30% and your debt-to-income ratio needs to be below 50%. Additionally, you should expect to pay standard origination and closing fees. A&D Mortgage is looking for credit scores of at least 500, and they will accept a loan-to-value ratio of up to 70%. The entire process takes a minimum of 5-7 business days once they have received your paperwork.

Another private non-QM lender, Angel Oak Home Loans, based in Atlanta, GA has a program specifically dedicated to serving foreclosed-upon borrowers with bad credit. Their program, Home$ense, was created specifically for homebuyers who were caught in the recession and mortgage crisis.

Home$ense allows you to begin the application process immediately after your foreclosure has settled. They offer 30-year fixed mortgages with interest rates of 5.5 percent to up to 9 percent, and they require a minimum 20 percent down payment.

These loans allow a loan-to-value ratio of up to 80% and don’t count late mortgage payments from the past 12 months against you. The average credit score of their borrowers is 670. Their loans are available for single-family residences, and they will approve up to $1 million for your loan.

Should You Wait to Qualify for an FHA Loan?

It’s easy to get caught in the excitement of purchasing a home, especially after a foreclosure. However, it may be smarter to exercise patience and wait 3 years to qualify for an FHA loan. This example illustrates why:
Non-QM
Credit score 620-639
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 5.5 to 9%
Full cost of mortgage at 5.5% $327,046
Full cost of mortgage at 7% $383,214
Full cost of mortgage at 9% $463,463
FHA Loan
Credit score 620-639
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 3.375% to 4.125%
Full cost of mortgage at 3.375% $254,647
Full cost of mortgage at 4.125% $279,158

Even without the full recovery of your credit score, it’s easy to see the differences in cost between these two types of loans. In addition to a significantly lower monthly payment, an FHA loan will save you a lot of money over the lifetime of the loan.

Comparing the Costs of Mortgages After Foreclosure

How much will a foreclosure affect your credit score? It depends on what credit score you started with. According to FICO, if your credit score is 780, a foreclosure will drop your score by 120-140 points. And if your credit score is 680, a foreclosure ding your score by at least 85-65 points. The higher your score, the greater of an impact your foreclosure will have. The lower your score, the less likely a lender will approve your loan, and if you are approved, you will probably be stuck paying higher interest rates.

Assuming your score has dropped to 620, here are a few examples of how much your mortgage after foreclosure may cost. These examples are for mortgages in Tennessee:

FHA Loan
Credit score 620-639
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 3.375 to 4.125%
Total cost for interest at 3.375% $94,647
Total cost for interest at 4.125% $119,158
VA Loan
Credit score 620-639
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 3.49 to 4.25%
Total cost for interest at 3.49% $98,328
Total cost for interest at 4.25% $123,357
Conventional Loan
Credit score 620-639
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 3.75 to 4.875%
Total cost for interest at 3.75% $106,755
Total cost for interest at 4.875% $144,824

Remember, credit score, home price, and down payment will all affect your interest rates. It’s also important to ask about points, mortgage insurance, and closing costs, which are not included in these examples.

Deficiency Judgements: What You Need To Know

If you’ve had a foreclosure, you need to be aware of the risks associated with deficiency judgements. Many lenders will forgive deficiency through a short sale before foreclosure. But be aware that lenders have the ability to file motions for old foreclosure lawsuits and hire debt collectors to go after your remaining debt, court fees, and attorney’s fees, plus any interest that has accumulated.

Fannie Mae and Freddie Mac lenders are among the ones doing this, and they are specifically targeting “strategic defaulters.” In 2011, Fannie Mae and Freddie Mac went after 12 percent of the 298,327 homes they foreclosed on for deficiency judgements. Fannie Mae has hired debt collectors in 38 states and Freddie Mac has taken foreclosed-upon homeowners to court in 17 states.

In a press release, Fannie Mae explained how they have instructed lenders to monitor delinquent loans facing foreclosure and make recommendations for cases that may warrant deficiency judgments. Additionally, they pointed out that borrowers who worked with lenders may be considered for foreclosure alternatives like a loan modification, a short sale, or a deed-in-lieu of foreclosure.

How does a deficiency judgement work? If your home had a $250,000 mortgage, the value may have decreased to only $150,000 after the financial crisis. If you foreclosed at that point, and your lender sold your home at its current value, the $100,000 difference would be the deficiency balance. A Washington Post investigation uncovered a story of a Rockville, MD family who lost their home to foreclosure in 2008. Over three years after their foreclosure, they were taken to court by lenders to collect their deficiency balance of $115,000, which included three years of interest.

Although deficiency judgements are not a common problem right now, they could come back to haunt you once you’ve recovered from a foreclosure, secured a better job, and have started rebuilding savings. Deficiency judgements are still allowed in 40 out of 50 states, and the statutes of limitation range from 30 days to 20 years. You won’t know it’s coming until you receive a court notice, and many times your debt will no longer be with the original lender. Interest may become one of the largest expenses, especially if your debt is old. And once there is a judgement, you will be stuck paying it off.

In many cases, filing for Chapter 7 bankruptcy may be the only way out. And that option may not be available if you earn more than your state’s median income by family size. If that’s the case, Chapter 11 or Chapter 13 may be your only other options.

Should You Wait To Apply?

When you’re ready to own another home, you may be tempted to try and re-enter the housing market as quickly as possible. However, rushing into the home-buying process may not be the right choice.

First, you should figure out when the negative mark on your credit report is due to be dropped. Start by checking your credit report from each of the three credit-reporting firms, Equifax, Experian and TransUnion, through annualcreditreport.com. It’s free every 12 months, and these reports will show you exactly when your foreclosure was recorded.

When it comes to applying for a new mortgage, timing is key. If there are only a few months left before the foreclosure is removed from your credit report, you may benefit from waiting until the black mark is gone. When lenders check your credit reports during the application process, they won’t see your foreclosure.

However, if you still have another year to go, and you want a mortgage, you may not benefit from waiting. Interest rates are on the rise, and there’s no guarantee they won’t be higher than what you are able to secure earlier — even with a blemished credit report.

Keep in mind some applications may ask questions about previous foreclosures, so you may be required to disclose this information either way. And the information about your foreclosure may make a lender think twice about your eligibility.

So does it make more sense to wait? Here are a couple of examples comparing the costs for FHA loans:

Example #1
Credit score 620-639
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 3.375 to 4.125%
Total cost for interest at 3.375% $94,647
Total cost for interest at 4.125% $119,158

This examples assumes your score has dropped to 620, you can afford a 20% down payment, and you’re looking for a 30-year fixed rate FHA loan in Tennessee. You have passed the three-year waiting period, but a foreclosure is still on your credit report.

Example #2
Credit score 720-739
Home price $200,000
Down payment $40,000 (20%)
Loan amount $160,000
Rate type fixed
Loan term 30 years
Interest rates 3.25 to 4.00%
Total cost for interest at 3.25% $90,679
Total cost for interest at 4.00% $114,991

This example assumes your score increased to 720 after your foreclosure was removed from your credit report. All other details are the same as the previous example. As you can see, the 100-point difference in credit score represents roughly $4,000 in savings over the lifetime of the loan.

Because interest rates are controlled by market forces outside of your lender’s control, you may want to think about how much rates may increase on their own within the timeframe of when you’re looking to qualify for a mortgage. We recommend using the Consumer Financial Protection Bureau’s interest rate tool as you are gathering data to make your decision.

General Tips On Being Approved For a Mortgage After Foreclosure

Regardless of which type of mortgage you decide to pursue, and the mandatory waiting period associated with it, cleaning up your finances will help the entire process go more smoothly:
Pay down all credit card debt

Paying your credit card debt off completely is one of the fastest ways to improve your credit scores. This type of debt compared to your spending limits accounts for 30% of your FICO scores. Once you’ve paid off your credit cards, you should see the change reflected in your credit score within a month.

Don’t apply for other loans

Resist the temptation of increasing your debt burden before applying for additional financing. This includes car loans, furniture loans, or appliance financing. Your debt-to-income ratio is one of the most important factors lenders look for when trying to determine your eligibility for a mortgage.

Avoid other blemishes on your credit report.

After your foreclosure, prioritize paying all of your bills or loan payments on time. You won’t want to begin the seven-year period of waiting for negative events to be removed again.

Conclusion

Losing a home to foreclosure can be a devastating experience, but you’re not alone. 7.3 million “boomerang” buyers who have lost a home over the past decade are preparing themselves to re-enter the housing market over the next several years. In fact, 25% of these foreclosed-upon buyers already have their foreclosure removed from their credit report. It’s important to take your time exploring all available options, selecting a program that best fits your current financial situation, and securing the best possible terms.

Our guide was designed to offer you a comprehensive overview of the options that are currently available, but it’s always a great idea to conduct a bit of your own research. With the large volume of borrowers seeking to re-enter the market in the next few years, additional options may continue to emerge.

Kate Dore
Kate Dore |

Kate Dore is a writer at MagnifyMoney. You can email Kate at kate@magnifymoney.com

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What to Know About the Mortgage Pre-Approval Process

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Mortgage Pre-Approval Process

As I sit here right now, I’m about to turn in my earnest check for the first ever house that my husband and I will have purchased. It’s the largest expense (by far) that either of us will have paid for, and to be honest, I’m pretty nervous.

If you’re considering buying a house, you know how much financial brewhaha goes into the process. Your entire monetary life is flashed before multiple peoples’ eyes, and you may never have done as much research on something before in your life. Luckily, there are some resources that can help you out when it comes to that research, like for example this Consumer Financial Protection Bureau Loan Estimate Explainer.

When it comes to your loan, there will be a lot of jargon that you likely won’t understand, so it’s important to ask as many questions as you need to and, if possible, meet with your loan officer in person to go over everything. For our part, having a local loan officer who has worked with our relator before was extremely helpful when it came to putting in an offer quickly in in the crazy Denver-area market. We had already started the conversation with our loan officer before finding the house we wanted (after searching around for different loan options that were competitive using this tool, we found that the local broker offered interest rates that were right in line with other big-name lenders, like Chase and USAA), and he had taken the time to go through the document point-by-point.

In terms of the loan estimate explainer, pay special attention to the ‘Review the Services You Can Shop For and shop for these services’ section, since this is the area of your loan document where you can have some say in how much you spend and who you use. As the site explains, the services listed in this section are required by the lender, but as the person getting the loan, you actually can save some money by shopping around for these services separately. Your lender should provide you with a list of providers for each of those services, and you can choose from the providers on the list. If he or she doesn’t, don’t hesitate to ask.

Remember that each state will have different rules, but for the most part, there should be at least a few services that you can have a say over. In general, title services like title insurance, title search and other costs associated with issuing the title insurance are included what you can shop around for. In our case, the sellers were responsible for picking the title insurance company, and while we could have a say in which company we ultimately want to go with, in deciding to do that research on our own and go with a separate company, we would be agreeing to take over the title fee from the seller, which wasn’t something we wanted to do.

While it might seem daunting to think about doing any outside research on your loan (on top of everything else you’re researching right now), keep in mind that it could save you hundreds, if not thousands, over the long run, so it might be worth it in the end.

If you’re close to closing on your own home, be sure to read this about how to shop around for title insurance and other closing cost services. Also check out this piece about what to know before getting pre-approved for a mortgage, and this one about when to apply for a mortgage without your spouse.

Cheryl Lock
Cheryl Lock |

Cheryl Lock is a writer at MagnifyMoney. You can email Cheryl at cheryl@magnifymoney.com

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