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What the New DOL Fiduciary Rule Means For You

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Seven years in the making, the Department of Labor’s long-awaited Fiduciary Rule finally went into effect June 9.* The full breadth of the rule’s impact won’t officially be felt until January 2018, when advisors must be fully compliant with the rule’s requirements.

The rule survived an upheaval by the Trump administration, which had hinted earlier this year that it might seek to block the rule’s implementation.

Aimed at saving consumers billions of dollars in fees in their retirement accounts, the Department of Labor’s new fiduciary rule will require financial advisers to act in your best interest. However, the final rule includes a number of modifications, including several concessions to the brokerage industry, from the original version proposed six years ago.

Here’s what you need to know about these new rules and how they may affect your money.

*This story has been updated to reflect the rule’s successful release.

What is a Fiduciary?

So what exactly is a fiduciary? According to the Certified Financial Planner (CFP) Board, the fiduciary standard requires that financial advisers act solely in your best interest when offering personalized financial advice. This means advisers can’t put personal profits over your needs.

Currently, most advisers are only held to the U.S. Securities and Exchange Commission’s suitability standard when handling your investments. This looser standard allows advisers to recommend suitable products, based on your personal situation. These suitable products may include funds with higher fees — with revenue sharing and commissions lining their own pockets —  which may not reflect your best possible options.

What is Changing Exactly?

Affecting an estimated $14 trillion in retirement savings, the Department of Labor’s new fiduciary rule is meant to help you receive investment advice that will aid your nest egg’s ability to grow. Many investors have been pushed toward products with high fees that quickly eat away at profits.

All financial professionals providing retirement advice will now be required to act as fiduciaries that must act in your best interest. This applies to all financial products you may find in a tax-advantaged retirement accounts. Because IRAs offer fewer protections than employment-based plans, the Department is concerned about “conflicts of interest” from brokers, insurance agents, registered investment advisers, or other financial advisers you may turn to for advice.

Despite these new protections, the Department of Labor also made some key concessions. Previously, brokers were required to provide explicit disclosures about the costs of products to their clients. This included one, five, and ten year projections. However, this requirement has been eliminated. After heavy pushback from the industry, the Department of Labor also agreed to allow the use of proprietary products.

Additionally, the Department of Labor has pushed the deadline for full implementation of their new rules. Firms must be compliant with several provisions by June and fully compliant by January 1, 2018.

Despite all of these concessions, the Department of Labor’s highest official insists the integrity of their rule is still in place.

Exceptions You Should Know About

Although advisers working with retirement investments will no longer be able to accept compensation or payments that create a conflict of interest, there’s an exception many brokers will likely pursue.

Firms will be allowed to continue their previous compensation arrangements if they commit to a best interest contract (BIC), adopt anti-conflict policies, disclose any conflicts of interest, direct consumers to a website that explains how they make money, and only charge “reasonable compensation.” The best interest contract will soon be easier for firms and advisers to use because it can be presented at the same time as other required paperwork.

How These New Rules Might Affect Your Investment Options

Although these new rules don’t call out specific investment products as bad options, it’s expected advisers may direct you to lower-cost products, like index funds, more regularly. New York Times also predicts the new regulations may also accelerate the movement toward more fee-based relationships. They also suggest complex investments like variable annuities may soon fall out of favor.

What Will the Larger Impact of These Changes Be?

Backed by extensive academic research, the Department of Labor’s analysis suggests IRA holders receiving conflicted investment advice can expect their investments to underperform by an average of one-half to one percentage point per year over the next 20 years. Once their new rules are in place, they are anticipating retirement funds will shift to lower cost investments, savings consumers billions of dollars.

What You Can Do To Protect Yourself

Although these new rules are a positive step for consumers, it’s important to remember there are still a wide variety of financial professionals out there. And the quality of the advice you receive can vary greatly based on their level of education, experience, and credentials. In order to find someone who is equipped to handle your unique financial situation, you will still need to do your homework.

You may want to start by looking for a fee-only financial planner. Due to the nature of how they are compensated, fee-only financial planners operate without an inherent conflict of interest. They are paid a fee for the services they provide and they don’t earn commissions from product sales.

Once you’ve narrowed down your options you’ll want to ask about their credentials, what types of clients they work with, what types of services they offer, while carefully checking their background and references. Like any professional working relationship, you’ll want to feel comfortable with someone you are receiving financial advice from, so it’s important to make sure your personalities and priorities are aligned. Remember, no one cares more about your money than you do. That’s why it’s essential to carefully vet anyone who is working with you to secure a healthier financial future.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kate Dore
Kate Dore |

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

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Mortgage

Guide to Getting a Mortgage When You’re Self-Employed

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

For some Americans, self-employment is the ultimate dream. Roughly 15 million people (10.1% of the total U.S. workforce) were self-employed in 2015, according to the U.S. Bureau of Labor Statistics. Self-employment offers workers the kind of flexibility that can be hard to find in a traditional 9-to-5 job, not to mention the potential for higher earnings.

However, self-employment does come with its own challenges, and, unfortunately, one of these difficulties can be homeownership. Despite earning a solid income, self-employed borrowers face a unique set of hurdles when it comes to determining whether they are eligible for a mortgage. In this guide, we will cover a number of requirements borrowers should begin preparing for as early as possible into their home-buying journey.

The Self-Employed Challenge

In order to gain a deeper understanding of what it takes to be approved for a mortgage as a self-employed borrower, it’s helpful to know how mortgages work in the U.S. For starters, most banks bundle up mortgages and sell them to Fannie Mae, Freddie Mac, or private investors.

To make those investments as safe as possible, Fannie Mae and Freddie Mac have a strict set of guidelines for lenders to follow when deciding which borrowers qualify for a mortgage. Because self-employed borrowers’ income can be unpredictable, they are considered higher-risk borrowers than W-2 workers. That means these guidelines are especially strict for self-employed borrowers.

Requirements for Self-Employed Borrowers: Fannie and Freddie

Although there are a variety of options for mortgages available, we are going to focus on eligibility requirements for self-employed borrowers seeking financing through Fannie Mae and Freddie Mac. Why? If you’re eligible for these loans, you will have access to the lowest interest rates and safest mortgages.

Fannie Mae

Fannie Mae’s Selling Guide outlines a strict set of rules about income for self-employed borrowers. Fannie Mae notes your business income (from a partnership or S corporation) reported on IRS Form 1040 may not necessarily represent the income that has been distributed to you. They point out it’s important to review business income distributions that have been made or could have been made while determining the viability of your business.

Eligibility for Fannie Mae

First and foremost, all borrowers (whether self-employed or not) need to meet Fannie Mae’s normal eligibility requirements:

  • You must be a natural person (living human being) who has reached the age at which a mortgage is legal in the area where the property is located. There is no maximum age limit for the borrower.
  • You must have a valid Social Security number or Individual Taxpayer Identification Number.
  • Per Fannie Mae’s Eligibility Matrix, credit scores must meet the following criteria:
    • Manually underwritten loans – 620 for fixed-rate loans, 640 for adjustable-rate mortgages (ARMs)
    • Desktop Underwriter loans – 620 for both fixed-rate and ARMs
    • Mortgages insured or guaranteed by a federal government agency (HUD, FHA, VA, and RD) – 620
  • The purchase of a single unit principal residence must have a loan-to-value (LTV) of no higher than 97%. If your loan-to-value ratio is less than 75%, a credit score as low as 620 is allowed.
  • Your debt-to-income (DTI) ratio should be no greater than 36%. If your DTI ratio falls between 36% and 45%, a credit score above 680 is required.
  • Fannie Mae now offers a 3% down payment option.

In addition to these requirements, self-employed borrowers have some additional hoops to jump through.

Verification of Income

In order to verify your employment and income, a lender will ask for a copy of your signed income tax returns (individual and sometimes business, as well) from the past two years. This paperwork must include all applicable forms.

A lender may also use IRS-issued transcripts from your individual and business federal income tax returns from the past two years. If you are using these, the information must be complete and legible.

If you use two years of signed individual federal tax returns, the lender may waive the need to see your business tax returns if:

  • you are using your own personal funds to fund the down payment and closing costs and can satisfy the reserve requirements;
  • you have been self-employed in the same business for at least five years; and
  • your individual tax returns show an increase in self-employment income over the past two years.

In certain situations, Desktop Underwriter, Fannie Mae’s automated underwriting system, will only require one year of personal and/or business tax returns if lenders document your income by:

  • obtaining signed individual and business federal income tax returns for the most recent year,
  • confirming the tax returns reflect at least 12 months of self-employment income, and
  • completing Fannie Mae’s Cash Flow Analysis (Form 1084) or any other type of cash flow analysis form that applies the same principles.

Analysis of Your Personal Income

Your lender will prepare a written evaluation of your personal income, including your business’s profit or loss, as reported on your income tax returns. This will help them determine how much stable and continuous income you have. It’s important to note this step isn’t required if you qualified using income you didn’t receive from self-employment. Examples include qualifying for the loan using a traditional W-2 salary or your retirement income.

Freddie Mac

Freddie Mac’s Selling Guide also provides an outline for lenders on how to assess the income for self-employed borrowers. Although there are differences, Freddie Mac and Fannie Mae use similar criteria when it comes to assessing self-employed borrowers.

Freddie Mac uses Loan Product Advisor, an enhanced automated underwriting system, to help ensure loans meet their eligibility requirements. Even if you aren’t using self-employed income to qualify for a Freddie Mac mortgage, they must enter your self-employed status into this software.

Verification of Income

Your lender will calculate your average monthly income based on a review of your complete federal individual income tax returns (Form 1040) including W-2s and K-1s and your complete business tax returns (Forms 1120, 1120S, and 1065).

Analysis of Your Personal Income

If you are self-employed but not using self-employment income to qualify, your lender will request to see your individual federal tax returns to see if there is a business loss that may have an impact on the stable monthly income used to qualify. If a business loss is reported on your individual tax returns, your lender may need to obtain additional tax returns to fully assess the impact of a business loss on income for qualifying.

Eligibility for Freddie Mac

In addition to these special requirements for self-employed borrowers, you also must meet Freddie Mac’s normal eligibility:

  • If you are a non-U.S. citizen who is lawfully living in the U.S. as a permanent or nonpermanent resident alien, you are eligible for a mortgage on the same terms as a U.S. citizen.
  • For a manually underwritten mortgage, your credit history must have at least three credit accounts (on or off your credit report) or four noncredit payment references. Noncredit payment references must have existed for at least 12 months.
  • You must have a valid Social Security number or Individual Taxpayer Identification Number.
  • Per Freddie Mac’s Minimum Indicator Score Requirements, credit scores must meet the following criteria:
    • For a single unit and primary residence with an LTV less than or equal to 75%, you must have a minimum credit score of 620.
    • For a single unit and primary residence with an LTV greater than 75%, you must have a minimum credit score of 660.
  • Your monthly housing expense-to-income ratio should be no greater than 25% to 28%.
  • Your monthly debt-to-income ratio should be no greater than 33% to 36% of your stable monthly income. If your debt-to-income ratio exceeds 45%, you won’t be eligible for a Freddie Mac loan.
  • The purchase of a single unit principal residence must have an LTV of no higher than 97%.
  • Freddie Mac now offers a 3% down payment option.

Requirements for Your Business

In addition to looking at your personal financial situation, Fannie Mae and Freddie Mac also are required to evaluate the financial health of your business.

Fannie Mae

Fannie Mae says you are self-employed if you have 25% or greater ownership interest in a business. In order to qualify, Fannie Mae also analyzes several components of your business.

Length of Self-Employment

Fannie Mae asks lenders to review a two-year history of your previous earnings. However, if you have a shorter period of self-employment (12 to 24 months), your most recent signed federal tax return must reflect your income. It’s important your past income was earned in a field similar to your current business. In these cases, the lender will give careful consideration to your level of experience and the amount of debt your business has acquired.

Analysis of Your Business Income

If you are relying on self-employed income to qualify for a mortgage, and you don’t meet the requirements to waive your business tax returns (as mentioned in the previous section), your lender will also prepare a written evaluation of your business income. Your lender will use their knowledge of your industry to help determine the long-term stability of your business.

The primary goal of this analysis is to:

  • consider the recurring nature of your business income, including identification of pass-through income that may require additional evaluation;
  • measure year-to-year trends for gross income, expenses, and taxable income for your business;
  • determine (on a yearly or interim basis) the percentage of gross income attributed to expenses and taxable income; and
  • determine a trend for the business based on the change in these percentages over time.

Your lender may use Fannie Mae’s Comparative Income Analysis or other methods to determine your business’s viability.

Use of Your Business’s Assets

If you are planning to use assets from your business for a down payment, closing costs, or financial reserves, your lender will need to perform a cash flow analysis to make sure this transaction won’t have a negative impact on your business. This may require additional documentation, like several months of recent business asset statements, to evaluate your cash flow needs over time.

Freddie Mac

Freddie Mac also characterizes self-employed borrowers as people who own at least 25% of a business. Your business can be a sole proprietorship, a partnership, an S corporation, or a corporation. You may notice several similarities when it comes to how Fannie Mae and Freddie Mac evaluate your business. However, there are some distinctions you should be aware of.

Length of Self-Employment

For Freddie Mac, the lender will be required to document a two-year history of your self-employment to ensure your income is stable. If your self-employment history is less than two years, the lender must evaluate your company’s products and services in the marketplace. They will also need to document your two-year history prior to self-employment to show you’re currently earning the same or a greater income in a similar occupation. The lender must consider your experience in the business before looking at your income, and your tax returns must show at least one year of self-employment income.

Analysis of Your Business Income

Your lender will analyze your tax returns and provide a written analysis of your self-employed income. Noncash items like depreciation, depletion, and amortization can be added back to your adjusted gross income. Documented nonrecurring losses and loss carryovers from previous tax years can also be added back to your adjusted gross income.

If you are using self-employment income to qualify, Freddie Mac requires lenders to analyze tax returns and provide a written analysis of your self-employed income. If your income has significantly increased or decreased, you will need to provide sufficient documentation to prove your income is stable. Additional tax returns may be needed if your self-employment income has fluctuated.

Freddie Mac recommends lenders be careful when including additional income you have drawn from your corporation, partnership, or S corporation as qualifying income. Your lender will need to confirm you have a legal right to that additional income. Your lender also needs to verify your percentage of ownership from a review of your business’s tax returns.

Location of Your Business

If you are moving to another region, your lender must consider your company’s service or products in the new marketplace before reviewing your income. You will need to document how your income will continue to be stable in a new location.

Use of Your Business’s Assets

If your business’s assets are used for a down payment, closing costs, financing costs, prepaid or escrows, and reserves, these assets must be verified and must be related to the business you own. The withdrawal of assets from a sole proprietorship, partnership, or corporation may have a negative impact on your business’s ability to continue operating. The impact of this transaction will be considered in your lender’s analysis of your self-employed income. You will need to provide documentation of cash flow analysis for your business using your individual and/or business tax returns. You can learn more about the required documentation here.

What Types of Properties Are Eligible for a Fannie or Freddie Mortgage?

When you are comparing mortgage options, it’s important to know which types of properties are eligible. Here are the basics to keep in mind as you are assessing each choice.

Fannie Mae

Fannie Mae is willing to purchase first-lien mortgages that are secured by residential properties for dwellings that consist of 1-4 units. However, there are some cases where the number of units may be restricted. The property must be located in the United States, Puerto Rico, the U.S. Virgin Islands, or Guam.

The property must be safe, sound, and structurally secure and must be adequately insured per Fannie Mae’s guidelines for property and flood insurance. It must be the best use of the property, must be readily accessible by roads that meet local standards, and must be served by local utilities. Lastly, the property must be suitable for year-round use.

Freddie Mac

Freddie Mac expects lenders to equally assess both a borrower’s eligibility and the adequacy of the property as collateral. Freddie Mac is willing to purchase mortgages secured by residential properties in urban, suburban, and rural market areas. The property must be residential, be an attached or detached dwelling unit(s) located on an individual lot.

The property must be safe, sound, and structurally secure and must be covered by property insurance that meets Freddie Mac’s hazard requirements. It must be the best use of the property, have legal access, and have utilities and mechanical systems that meet local standards. It must be suitable for year-round use and not be subject to a pending legal proceeding.

Where to Go if Fannie and Freddie Reject You

If you don’t qualify for a mortgage backed by Fannie Mae or Freddie Mac, there are a number of private lenders worth exploring. These are considered nontraditional lenders. Some of the more reputable ones include SoFi, Quicken Loans, and PenFed, among many others. Additionally, you may want to reach out to major banks to learn about their nonconforming product options.

SoFi

SoFi’s unique proprietary underwriting uses free cash flow as the primary criterion in determining your eligibility. They also look at a history of financial responsibility and professional responsibility. For qualified borrowers, they offer mortgages with 10% down payments and no mortgage insurance for their 15-year and 30-year mortgage products. They also offer a 30-year 7/1 ARM. This is a hybrid mortgage that begins with seven years at a fixed rate, and changes every year after that.

Interest rates depend on your qualifications and the overall mortgage rate environment, but typically fall in the low 3% to low 5% range for both 15-year and 30-year mortgages.

SoFi estimates 10% of their borrowers are self-employed, so they are well equipped to assess each individual’s unique financial position. They cite their unique underwriting model and commitment to personal service as creating a friendly environment for self-employed borrowers. Additionally, SoFi doesn’t impose restrictions or rate adjustments for self-employed borrowers.

Quicken Loans

According to Quicken Loans, self-employed borrowers are eligible for all the same loans and terms as traditionally employed W-2 borrowers. The key difference is self-employed borrowers need to provide tax returns documenting their business’s income. They like to see two full years of tax returns with stable to increasing income. However, there are some situations on conventional loans that only require one year of tax returns if your business has existed for 5 or more years.

Quicken Loans points out some self-employed borrowers tend to keep all of their assets in business accounts. This can complicate documentation requirements when funds for closing are not from personal accounts. In these types of situations, they usually require business tax returns to review cash flow. This ensures the funds being used to buy a home won’t jeopardize the health of the company.

Conventional loans over 80% LTV require mortgage insurance, while FHA and VA loans have insurance built into the program, regardless of LTV.

Here are their general credit and debt-to-income guidelines for each type of loan:

  • Conventional – minimum FICO 620 and maximum DTI 45%.
  • FHA and VA – minimum FICO varies but is typically 580. DTIs will vary by lender but typically are permitted to 50%.
  • Jumbo – minimum FICO is typically 700 and the maximum DTI is typically 43%.

When it comes to eligibility, there is no difference between self-employed and traditionally employed borrowers for credit score, loan-to-value, or debt-to-income ratios. Quicken Loans also noted self-employment isn’t a deciding factor for interest rates. However, it’s important to know you probably won’t be approved with an income decline of more than 25%.

PenFed

PenFed, a national credit union headquartered in Alexandria, VA, verifies income of self-employed borrowers through copies of personal and business federal tax returns from the past two years. You are required to provide complete tax returns, including all schedules and supporting documents. In some cases, you may also need to provide corporate tax returns for companies you have significant ownership in.

PenFed reviews and averages your net income from self-employment that is reported on your tax returns to determine your income that can be used to qualify. If your income hasn’t been reported on your tax returns, it won’t be considered. Usually PenFed requires a one-year and sometimes a full two-year history of self-employment to prove your income is stable.

Nonconforming Loans from Traditional Lenders

It may not be the first option that springs to mind, but some banks do originate loans. These loans tend to be nonconforming and have higher interest rates.

For example, Chase offers jumbo mortgages for loans between $417,000 and $3 million. These are both fixed-rate and ARM loans for up to 30-year terms.

For these types of products, Chase typically will only work with existing customers, depending on their assets. If you don’t have a prior relationship with the bank, you won’t be eligible. If you’re interested in a nonconforming product, Chase recommends starting by applying for pre-qualification here.

In order to be approved for these types of products, you must meet the following requirements:

  • Credit score – 680 minimum
  • Down payment – 15% without mortgage insurance
  • Reserve balance – 18 to 24 months
  • Debt-to-income ratio – no more than 45%

When it comes to interest rates, Chase factors in all the above criteria. However, the larger the loan, the better rates are available. They prefer to use your pre-qualification information as a starting point and work through interest rate options from there.

How to Comparison Shop for a Mortgage Loan

Did you know nearly half of mortgage borrowers don’t comparison shop? A recent Consumer Financial Protection Bureau (CFPB) study found 77% of borrowers only apply with one lender or broker. These same borrowers were quick to rely on salespeople rather than doing their own research.

As we have outlined, mortgages are available through a variety of types of lenders. Because the process of qualifying for a mortgage when you are self-employed requires additional legwork, and may be more expensive, it’s even more important to shop around.

The CFPB’s interest rates tool is a great place to start. By plugging in your credit score, state, home price, and down payment percentage, you can see a graph of lenders and interest rates being offered in your region. Although this tool doesn’t state which lenders are offering these rates, you can Google the rate + your state + mortgage to find out exactly where it is being offered.

Remember, lenders want your business, and knowing what else is available will only give you more leverage. Like any other mortgage, you will want to ask about points, mortgage insurance, and closing costs. You can compare each lender’s Loan Estimates before making a final decision.

For conforming loans, backed by Fannie Mae or Freddie Mac, you can try the above tactic for shopping around. You can also try local banks and credit unions. For private lenders like SoFi, Quicken Loans, or PenFed, you are better off reaching out to these companies directly. For nonconforming loans from traditional lenders, it’s easiest to start with banks you have an existing relationship with.

Here is an example to help you determine what is right for you:

Conforming Loan from Fannie Mae or Freddie Mac

This example is for the state of Tennessee:

Credit score – 680-699
Home price – $200,000
Down payment – $6,000 (3%)
Loan amount – $194,000
Rate type – fixed
Loan term – 30 years
Interest rates – 4%-4.625%
Total cost for interest rates at 4% – $333,360
Total cost for interest rates at 4.625% – $358,031

Nonconforming Loan from SoFi

Credit score – 680-699
Home price – $200,000
Down payment – $20,000 (10%)
Loan amount – $180,000
Rate type – fixed
Loan term – 30 years
Interest rates – 3%-5%
Total cost for interest rates at 3% – $273,240
Total cost for interest rates at 5% – $347,860

Keep in mind credit score, home price, and down payment will all affect your interest rates. You should ask about points, mortgage insurance, and closing costs, which are not included in these examples.

Start Preparing Now

The entire process may feel daunting, but there are a number of things you can start doing now in order to put your best financial foot forward:

  • Stay Organized Keeping pristine records of your company’s profits and/or losses is a smart practice whether you are applying for a mortgage or not. Staying on top of paperwork from the beginning will be helpful for both you and your loan officer.
  • Avoid Co-Mingling Funds One of the biggest mistakes self-employed individuals make is co-mingling personal and business funds. Lenders may want to see separate statements for your credit card, checking, and savings accounts. If you are feeling overwhelmed by the process, you can start by comparing our favorites.
  • Improve Your Credit Score A recent Zillow study found self-employed borrowers are twice as likely to have a FICO score below 680. It’s never too soon to start making improvements. Start by pulling free reports from all three credit bureaus — Experian, Equifax, and TransUnion — once per year from AnnualCreditReport.com. Once you are armed with your current scores, you can take action with our credit score guide.
  • Pay Down Debt Regardless of your employment status, it is nearly impossible to be approved for a mortgage if your debt-to-income ratio is above 45%. In most cases, a maximum debt-to-income ratio of 33%-36% is preferred. If you are above that range, paying down debt will improve your chances of being approved.
  • Save a Larger Down Payment Offering a larger down payment may provide additional leverage when it comes to eligibility.
  • Build Up Your Cash Reserves Having a sizable emergency fund can signal to lenders you are prepared for the inevitable dips in income self-employed borrowers face. Help ease your bank’s nerves about irregular income by having extra cash on hand.
  • Carefully Evaluate Tax Deductions If you are planning to purchase a home within the next few years, it’s critical to begin weighing the pros and cons of your business’s tax deductions now. It may be worth writing off fewer business expenses in order to qualify for a less expensive conforming mortgage. This step is worth discussing with a trusted tax professional. For more information on self-employed taxes, you can visit the Self-Employed Individuals Tax Center.

Final Thoughts

When it comes to homeownership, there is a lot to think about, and being approved for a mortgage is just the beginning. The stress of buying a home is only elevated for self-employed borrowers, who face additional hurdles each step of the way. However, the process doesn’t have to be overwhelming. By crafting a game plan as early as possible, and sticking with it, you will have the best possible chance of being approved.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kate Dore
Kate Dore |

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

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The Guide to Getting a Mortgage After Foreclosure

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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.

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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 score620-639
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates5.5 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 score620-639
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates3.375% 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 score620-639
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates3.375 to 4.125%
Total cost for interest at 3.375%$94,647
Total cost for interest at 4.125%$119,158
VA Loan
Credit score620-639
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates3.49 to 4.25%
Total cost for interest at 3.49%$98,328
Total cost for interest at 4.25%$123,357
Conventional Loan
Credit score620-639
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates3.75 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 score620-639
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates3.375 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 score720-739
Home price$200,000
Down payment$40,000 (20%)
Loan amount$160,000
Rate typefixed
Loan term30 years
Interest rates3.25 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.

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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.

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Kate Dore
Kate Dore |

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

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