If you're thinking about buying a house or refinancing a loan, you probably know the sobering realities in the mortgage market: thanks to strict federal rule changes in the wake of the housing bust, it can be tough to qualify for a loan.
That's especially true if you don't quite fit the mold — you don't conform to all the underwriting mandates on credit, income, debt-to-income ratio and other criteria. You can handle the payments, but issues in your credit history and application push borrowers “outside the box” that defines Qualified Mortgages, or “QM”.
That being said, a small but growing number of lenders have begun offering mortgages with more flexible terms designed for borrowers that don’t meet the stringent requirements set up by the Consumer Finance Protection Bureau. Borrowers with solid credit scores and/or money in the bank but that student loans or uninsured medical bills push debt-to-income ratios over the maximum that federal rules generally prescribe have programs open to them.
Self-employed borrowers have options, as well as anyone who did a short sale on their underwater home a couple of years ago too recently to meet the four-year minimum wait time prescribed by Fannie Mae or Freddie Mac before you are allowed to obtain a new mortgage.
Borrowers may choose to wait until their credit improves, their job is stable, or the prescribed waiting period is over. But another option for "near-miss" applicants or potential applicants nationwide has begun taking shape: "non-Qualified Mortgage" or non-QM lending. Interest rates are higher than the standard market, but certain programs are being created to help certain borrowers – and that helps the housing market.
When you start the process of applying for a mortgage, you may feel as though you're giving every single bit of personal and private information to your mortgage lender. Just why does your lender need to know all of those things? Are your personal financials and credit history really necessary just to get a quote?
As you approach a loan officer to apply for a loan, you should be prepared to deliver quite a bit of personal information. Taking a closer look at how the loan industry works will help you understand why this is necessary.
Increased Scrutiny Means Increased Details
In the early 2000s, lenders were known for having loose underwriting for mortgages. Many people were given mortgages that they really were not qualified to have, and this led to the financial crisis of 2008 and the following real estate slump. Now, lenders are facing tighter scrutiny from the Consumer Financial Protection Bureau, and this has triggered increased requirements when borrowers approach lenders in pursuit of a loan. In order to get a mortgage, you are going to have to give up a lot of details and prove that you are credit worthy.
Why a Credit Pull Is Vital
Borrowers who suspect they may have credit problems or who are private in nature may wish to wait to have their credit checked until they're certain they've chosen the right lender and loan. Also, some borrowers don't want to approve the credit check because they don't want to have a credit pull on their history. However, your chosen lender can't offer loan terms without pulling your credit, and if you want to have more than one quote, each lender you apply to is going to have to pull your credit. These credit pulls do have a temporary impact on your credit report, but as long as you don't have an excessive number of inquiries for different types of loans, this shouldn't create a problem.
A Full Financial Picture
Your credit score is just part of the picture that your lender will need. Your lender's also going to need to know your financial situation. This includes your income, investments and other debts. This, combined with your credit rating, will show the lender whether or not you are a safe risk. Once the lender has all of this information, they can provide you with a loan that fits your financial profiles. If there are problems, the lender can also help you know what to do to improve your credit and financial profile. If you're denied, the lender will tell you why, and you can take measures to change your situation and improve your chances of being approved for the next loan.
So yes, when you apply for a loan, you will need to offer up quite a bit of personal and financial information. It's simply part of the process. To limit the number of credit pulls and disclosure you are required to make, shop for lenders first and narrow down your choices to a couple, then apply, but don't be afraid to give up your information, because without it, you can't get a loan.
Underwriting guidelines change all the time. But interestingly, one thing that is somewhat constant is the amount of down payment due at the closing table. Many borrowers find, however, that coming up with the cash for the down payment has perhaps been the biggest obstacle to homeownership.
Seventy-five years ago, banks would only loan money to buy a house if the homebuyer had 30 percent or more of the sales price for the down payment. Even in 1935 when the average price of a home in the United States was $3,400, coming up with $1,000 for a down payment was a challenge. After all, the average income of a worker was just $1,500 per year. But in the 1930s the government decided to step in and help Americans buy their homes, and the Federal Housing Administration (FHA) was created to offer prospective homeowners the opportunity to buy a home with a small down payment and a stable 30 year fixed rate loan.
Today, our government, through the FHA, insures lenders who offer FHA loans. These loans have many benefits but probably the most noteworthy is that FHA insured loans allow a homebuyer to buy a home with as little as 3.5 percent down and to borrow as much as $729,750 (in a high-priced housing market) at a competitive 30-year fixed rate. FHA loans are typically more lenient on credit and allow a borrower to spend more of their monthly income on their house payment than conventional loans. They also allow a borrower to receive all of the down payment as a gift.
But FHA-insured loans also have their downsides. For example, FHA loans require mortgage insurance on every loan, despite the size of the down payment, and that mortgage insurance effectively adds up to 1.35 percent to the note rate. In other words, if the 30-year fixed rate today were 3.25 percent, the effective rate for an FHA loan would be over 4.5 percent.
Alternatively, the conventional financing offered by Freddie Mac and Fannie Mae requires the borrower to pay for mortgage insurance only if there is less than 20 percent for the down payment. Mortgage insurance may be paid either on a monthly basis or as a lump sum at the close of escrow. The precise payment options are dependent on the loan to value ratio, the loan amount and the credit score. Unlike with the current FHA loans, mortgage insurance on conventional loans does not continue throughout the life of the loan.
Often lenders are asked by buyers, “How much should my down payment be?” There are two sides to the question, with the buyer usually wanting as little as possible and the lender wanting as much as possible. Generally the two meet in the middle, and with good reasons.
Many buyers are limited as to how much down payment they need for a transaction due to the limit on how much money they have. Other buyers have more flexibility with down payment from the minimum required for the mortgage program for which they are applying to putting 30% or more into the purchase. The more money that is put into the down payment, the lower the mortgage rate. An aversion to debt, to monthly payments, to paying interest is not uncommon-especially following the mortgage and housing market collapses several years ago.
But “cash is king” and getting cash out of a bank account, or many different types of investment accounts, is a lot easier and cheaper than converting home equity into cash at a later date. To access equity from a home the owner either needs to obtain a second mortgage or HELOC that has transaction fees and a either a higher fixed rate or an adjustable rate, fund a cash out refinance of the primary mortgage which has transaction fees and possibly a higher rate than what a rate would be in today's market or sell the home.
There are plenty of other questions to answer. Does the borrower have a definite need for a large sum of cash in the near or medium future? Children attending college? Planned major remodeling project on the new home after moving in? Opportunity to buy into ownership or partnership at one’s business? With the new housing payment and expenses what will be the buyer’s ability to put aside money for savings, investments, retirement? Will this ability be severely impacted by a higher mortgage payment and retaining a large sum of money in those accounts you currently have? How long does the borrower intend to be in the property?
It is important to consider all of the "what-ifs" and do the math on those what-if propositions. Maximizing your down payment may be the best option for the borrower and their family, but it may not be depending on goals and objectives in the future.
Our agents are sometimes asked, “Why are mortgage rates different?” It is important for borrowers to remember that mortgage rates and interest rates in general, are determined by different factors, so an understanding of how mortgage rates are determined will help to better understand how banks and mortgage lenders set interest rates.
Every loan scenario is different, with different amounts, different borrower credit scores, different types of housing etc. – dozens of variables - and each loan must be priced accordingly. The predominant factor in determining interest rates and prices, however, is the risk of default risk, which is called “risk-based pricing.” The higher the risk, the higher the rate.
Banks and lenders start with a base interest rate and then either raise it or lower it based on the loan criteria. These include loan amount, documentation (full, limited, or stated), credit scores, occupancy, loan purpose (purchase or refinance, and if there is cash out), Debt-to-Income Ratio, property type, loan-to-value, and so on. In recent years, for example, loans made on non-owner occupied properties, or loans to borrowers with low credit scores have defaulted at a higher rate than other types of loans, and thus the rates are higher. And loans that do not fall under the maximum mortgage loan sizes set by Freddie and Fannie are usually pegged at a higher rate, since those loans are not easily bought and sold in the secondary markets.
Our borrowers often come to us with an ad from a newspaper, TV, or radio. Any rates that we hear about in the media are usually a best-case scenario: owner-occupied single family home, a perfect credit score, a huge down payment, and a conforming loan amount. Few of our borrowers are perfect, and as a result, they’ll see different mortgage rates. And “different” often means higher depending on the factors listed above.
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