Mortgage Qualification Basics

Qualifying for a mortgage is easy to understand if you think about the 4 legs of a chair. Each leg is equally important. A longer leg cannot compensate for a shorter leg. A lender needs stability from each leg in order to feel comfortable giving you a loan. It’s no different than feeling uncomfortable sitting on a wobbly chair. Sure it might support you for a time, but would you risk standing on it to change a light bulb? Without getting too metaphorical, the standing on the chair reference would relate to an extreme set of economic events that would challenge many in making their payments on time.

Let’s move to the practical, and get down to basics on these 4 legs. But more important, what makes a leg strong or weak – or in some cases no leg at all.

Leg #1 – Credit:
All mortgage financing is based on your credit score. The higher the score, the better rates and terms you will receive. If you have never been issued any credit in the past, you will not get a mortgage. This is different than not having a credit score. In some cases when there’s been no activity for a number of years, there’s not enough data to generate a credit score. There are now provisions to help this category of applicants. But if you have never been issued any credit in the past, you are not going to get a loan. The guideline is for a minimum of 3 active reported accounts. If you are short on that requirement, you could also find yourself not getting approved.

Here’s a simple fix: Collateralized Credit Cards. There’s lots of them out there. You put as little as $500 in an insured FDIC bank account, and the bank gives you a credit card with a limit that matches what you put in savings. When selecting the right card, make sure the card you choose reports your credit history to all 3 credit repositories. If you do decide to move forward and get some additional credit for yourself, make sure your do this as early as possible. Having new credit that has very little reporting to it is actually worse.

Leg #2 – Income:
You gotta have money in order to pay the bills, right! The days of stated income and no income verification loans are gone (although they are making a comeback – we’ll save that discussion for another newsletter). Income qualification is by far the most complicated of the 4 legs.

Now while there are exceptions to almost every rule (just like in the credit section above), you must have stable, reported income in order to qualify for a loan. What’s stable? In general, 2 years in the same line of work, receiving the same type of pay, without any major gaps. To break that down even further, yes you can move from job to job, but you have to be doing the same type of work. You can’t go from being a laborer to a librarian, without a majority of the 2 years in that new field. If you receive commission or bonus pay, you have to have a 2-year history of receiving it. It’s okay, even if you switch jobs, so long as how you are paid remains consistent. You can’t have major gaps in employment. Being employed solidly for 10 years but then being out of work for 7 months before you land that new job doesn’t count. What counts is how long have you been on that new job. If you are self-employed, you must have a minimum of 2 years of that income reported on your Federal tax returns in order to use it.

It seems that everything is 2-years? That’s how underwriting defines stable income. You want a stable chair, you need income that is regular and stable. And now that the government requires lenders to determine if a borrower really has the ability to actually repay the loan, no perfect credit score, no amount of cash in the bank, and no amount of equity in a home can make up for the lack of income. This is one leg of the chair that truly needs to hold up its portion of the weight.

Leg #3 – Funds Required for the Transaction (Cash)
We call it cash, but cash is the last thing anyone in a real estate transaction wants to see. When we refer to cash, we are really talking about verifiable liquid depository assets. All involved in real estate transactions are now bound by rules of the patriot act and anti-money laundering banking rules. Don’t even think about using the money you have in a home safe or under the mattress or in a sock drawer.

All funds for a mortgage transaction must be supported by statements that cover the most recent 60 days. If you get statements every month, you must provide two. If your statements are quarterly, you only need to provide one. Screen shots from your computer showing online activity rarely are accepted, because anything other than a regular statement must contain the account holder’s name, account number, and web address URL (www……com) at the bottom.

Remember, the funds also have to be liquid. That means that if the money you are going to use is holding mutual funds or other types investments, those funds must be liquidated (to determine their actual cash value) prior to the final loan approval.

Any funds that cannot be properly verified are treated as non-existent.

Leg #4 – Collateral (the property)
I can’t say this often enough – if you plan on getting a loan on a property for 30 years, it has to be in at least decent enough condition to last 30 years. Sudden large expenses could severely impact a borrower’s ability to repay their mortgage.

Most underwriting guidelines require the property to be in decent condition. It can’t have issues, which if left unattended, would lead to expensive fixes. Termites, exterior portions of the home missing paint, broken windows, are just some of the items that if left unattended, would result in thousands of dollars in repair bills.

Health and safety issues are also a big concern in lending. Mold is very common in Hawaii. If an appraiser notes mold during the inspection, expect to have the situation remediated by professionals – and at a large cost. But even a simple issue like a staircase missing its railing may need to be addressed prior to you getting your loan.

And of course, the most common issue with property in Hawaii – unpermitted improvements. I am asked whenever this comes up, why it is such an issue. The county may require those improvements to be removed. That is why an appraiser cannot count any of it when calculating the value of the home. Also, you never know what is lurking behind those walls. One poor solder joint on a plumbing pipe, and you could wake up one day with a flooded home.

Bad credit or not credit, have income but it isn’t regular or hasn’t been earned for a long enough period, have money but it’s not in the bank, found a great deal on a house but it wasn’t ever permitted…leak legs for a chair you are asking a lender to sit on for 30 years. My best suggestion to anyone wishing to buy a home is to talk to a competent lending representative about every aspect of your qualification. The best time to find out if you have any issues is not when you are about to put in an offer, but as early in the process as possible.