It used to be possible to borrow vast amounts of money to buy a home with almost no documentation. But since borrowers who can’t prove their income are more likely to default, the banking industry has become much more careful about who can borrow money-which means even very strong buyers have to supply stacks and stacks of documents to prove they’re worthy.
If you’re applying for a mortgage, you can expect your lender to ask you for most of the items on this list-and perhaps even more if your situation is at all unusual.
1. Tax Returns: The lender wants to be reasonably sure that your paycheck is high enough to allow you to meet the mortgage payments every month. They feel more confident if your salary has been relatively stable for the past few years. That’s why most lenders will ask to see tax returns going back at least two years. If your income has jumped recently, the lender may want additional documentation to assure them that it wasn’t just a one-time windfall, like a bonus that is unlikely to be repeated.
2. Pay Stubs: The tax returns prove what you income was last year and the year before, but your recent pay stubs tell the lender that you’re still earning the same amount.
3. Other Proof of Income: What if you don’t have pay stubs, or if your pay stubs only tell part of the story? If you’re self employed, receive child support, or have another source of income that isn’t through an employer, expect to provide even more documentation. 1099 forms, copies of checks, and bank statements showing direct deposits all help to show the bank your income is reliable.
4. Employment Letters: A letter from your employer confirming your hire date, current employment status and salary will go a long way toward comforting a nervous lender. This is a fairly standard piece of documentation, and there are plenty of samples online. Employment letters can also explain gaps in employment, such as time off without pay for the birth of a child. Your employer should explain why you took the time off, and verify that your return to work is permanent.
5. Proof of Funds: Now that the lender is reasonably sure you’re gainfully employed, they’ll want to verify that you have the money to cover the down payment and closing costs. They also want to know that you won’t be totally broke after the purchase, and that you have the money to weather a reasonable emergency. Statements from your bank and investment company will usually do the trick. Again, you’ll need statements going back a few months. If you’ve recently received a big check recently, such as a gift from your family to help with a down payment, the lender may require you to supply a letter from the person who gave you the money explaining that it’s a gift and you won’t be required to pay it back.
6. Photo ID: That’s right-the lender wants to make sure you are who you say you are. A copy of your driver’s license is usually sufficient.
These are some of the standard pieces of documentation your lender may require, but they will supply you with a complete list. So go ahead and start shopping for a loan!
Recently, there has been a subtle shift in the way FICO scores your credit. You may not notice this change and you may not even think it’s important. But it’s something you should care about if you own property. This is especially true if you were planning on using real estate to fund your retirement. This new FICO scoring criteria could bring about very nasty market conditions for real estate owners.
What’s Going On?: FICO isn’t going to ding people with specific blemishes on their credit history anymore. There are three events that used to hurt people’s scores that no longer do:
If they had a debt written off and then paid it.
If they have little credit history — or none at all.
If one or more of their medical bills were written off.
A Little Background — What is a FICO Score?: FICO scores try to assess how financially responsible people are going to be based on their credit history. They are provided by a private company by the name of Fair Isaac. This company has been calculating and selling consumer FICO scores since 1989. They’ve done a pretty good job and their data is used by over 90 percent of the financial institutions in the United States. The reason that so many financial institutions rely on FICO scores is because they are very accurate predictors of future financial behavior and risk. Businesses use the sores to decide whether or not to advance credit to consumers.
Why is this happening?: The Consumer Financial Protection Bureau “negotiated” with Fair Isaac to change the way they calculate FICO scores. As the CFPB saw it, too many people were locked out of the credit market because of their past. Because FICO took points off for past credit hiccups, those people were unable to get mortgages or credit cards. Even if they did get credit, they had to pay higher interest rates because of their past. (In addition, FICO scores are often used by would-be employers and consumers with tarnished credit found it more difficult to find jobs. That was also something the Consumer Financial Protection Bureau wanted to change.) With the new criteria that FICO uses now, millions of Americans will see their credit score jump up to 25 points. Those extra points will make a big difference. Many of those people will get credit they were otherwise unable to obtain.
In my opinion, there is plenty wrong with it. Of course nobody knows what the future holds, but I can’t see how this change helps anyone. Keep in mind that FICO scores are the most respected credit score on the market. They are used globally because the scores are good predictors of risk as I said before.
This change artificially inflates scores but it doesn’t change the risk that the banks will have to take. It’s true that more buyers may push prices up initially, but that may be a short-lived phenomenon.
Remember, these people had bad credit scores because they posed higher risks to lenders. The chances are high that their default rate will be the same as it ever was. So more people will be given loans they can’t afford. When they default, they’ll lose their down payment and end up with an even worse credit scores too. If those defaults pile up, it will hurt everyone; property owners, banks, construction workers — you name it.
Of course the law of unintended consequences is always at work. It’s possible that this could turn out to be good — although I don’t see how. It’s also possible that the banks will find a way to impose strict guidelines to make sure they don’t make the risky loans the Consumer Financial Protection Bureau wants them to make.
Even if the banks are forced to make these loans, it will take some time before the inevitable defaults and foreclosures start cascading in. That’s why it’s important for real estate investors to be aware of these FICO score changes and to keep their eyes on how this plays out in the real estate market.
Having trouble qualifying for a mortgage? Ben S. Bernanke, former chairman of the Federal Reserve, has the same problem. Bernanke, now a think tank consultant who earns a reported $250,000 for giving one speech, recently told a Chicago conference that he’s had a hard time refinancing his Washington, D.C. home.
“Just between us,” Bernanke said, “I recently tried to refinance my mortgage and I was unsuccessful in doing so,” Bloomberg News reports.
At first glance, this does not compute. Bernanke, who led the country and economy through the financial crisis, surely is no pauper, though he did buy his house during the real estate boom in 2004 for $839,000; it’s currently assessed for $815,000, said the The New York Times after looking at D.C. property records.
But Bernanke did commit the mortgage crime of changing jobs a few months ago, which, in the nether world of mortgage finance, makes him a credit risk.
I feel your pain, buddy. As a contract writer, I have a constantly revolving client list. And even though I’m doing well, thank you very much, mortgage officers have looked at my pay stubs from different employers as so much trash. One mortgage officer said none of my income would qualify until I worked for the same company for three years — an eternity in the writing game.
Not sure that’s the same problem as Bernanke: Just had to get if off my chest.
But the former head of U.S. financial policy recently left an eight-year gig with the Federal Reserve, where he got a steady paycheck, for the more unpredictable world of consulting and speechifying and book writing.
Bernanke revealed his mortgage troubles (cry me a river) to show that U.S. credit is still tight. And one reason is that inflexible lending formulas are deciding creditworthiness, rather than human mortgage officers (well, maybe human is overstating it).
Some say this tightness is holding back the U.S. housing market from a faster recovery.
The safest mortgage on the market since the housing crash is one where most buyers put $0 down. Wait, huh? Welcome to the surprising world of VA home loans.
About 9 in 10 buyers using this historic benefit program purchase without making a down payment. Despite that, these government-backed mortgages have had the lowest foreclosure rate of any loan type for 19 of the last 26 quarters, according to figures from the Mortgage Bankers Association. The safety and stability of the VA loan program remains one of the more under-reported trends in all of housing. An Urban Institute study released this past summer highlighted the VA’s foreclosure track
Since 2008, the VA has helped more than 320,000 homeowners avoid foreclosure, saving an estimated $11 billion in potential foreclosure claim payments.
record, but it’s a mostly under-the-radar success story. That’s not to say the lending industry needs some seismic shift away from “skin in the game.” There’s clearly a benefit to and place for down payments.
VA loans are also a hard-earned benefit reserved for those who serve our country. It’s a special program, and it should stay that way. But these zero-down loans do offer some lessons worth a closer look.
Big Benefits: VA loan volume has soared 372 percent since the crash, driven mostly by a tighter lending climate, a tough economy and bottom-barrel interest rates. VA loans feature more flexible and forgiving requirements than conventional loans, including lower credit score benchmarks, no mortgage insurance and closing costs limits.
But the single-biggest benefit is the ability to purchase with $0 down. Qualified borrowers in most parts of the country can purchase up to $417,000 before needing to factor in a down payment.
Since 2008, nearly 90 percent of VA buyers have purchased without a down payment. Yet, for almost five full years, these loans had a lower foreclosure inventory rate than all others, including prime loans.
The reasons why have a lot to do with common-sense underwriting and a commitment to helping veterans not just get into homes but keep them.
Residual Income: One is VA’s unique requirement for discretionary income. This standard, known as residual income, requires borrowers to have a minimum amount of money left over each month after paying their mortgage and other major expenses. How much varies based on geography and family size.
For example, a family of four in the Midwest would need at least $1,003 in residual income each month. Buyers with a debt-to-income ratio above 41 percent must meet an even higher benchmark and exceed the guideline by at least 20 percent.
Debt-to-income ratio is still the major focus in mortgage lending. But residual income can offer a more realistic look at affordability and a borrower’s ability to keep up with their mortgage payments if emergencies occur.
Closing out its look at why VA loans outperform FHA in terms of default, the Urban Institute encouraged other loan programs to consider adopting a residual income standard.
“We believe this test can be a powerful indication that the borrower will find the mortgage payments sustainable,” the authors noted. “We believe the residual income test can have applicability beyond the VA market.”
In addition, unlike with FHA financing, the VA guaranties only a portion of the loan in case of default. Lenders pay a steeper price when loans go sour, which has historically encouraged flexible-but-prudent underwriting.
Helping hands: The VA doesn’t actually make or directly service home loans, but it has the authority to intercede on behalf of borrowers on the edge. More than 150 loan program employees focus solely on homeowners facing default.
These foreclosure specialists receive a notification whenever a VA-backed loan is more than 60 days past due. They follow up directly with the veteran and often push lenders to offer alternatives to foreclosure, like loan modifications, repayment plans or forbearance.
Veteran Makeup: VA borrowers themselves deserve a lot of credit for the program’s success. You didn’t see a lot of military members walking away from their homes during the peak of the foreclosure crisis.
This is a group that takes seriously the idea of duty and obligation, even when it comes to a mortgage payment. That sense of commitment is also applicable beyond the VA market.
If you live in a community within a homeowners’ association, you probably have to pay association dues. They can run anywhere from less than $100 a year to more than $1,000 a month, depending on the community. What happens if you don’t pay? Will it ruin your credit rating?
It certainly can, as some of our Credit.com readers have found out:
“Not Guilty” is dealing with damaged credit as the result of judgment arising from unpaid (and disputed) HOA dues.
“Justneedmoretime” can’t get a loan modification due to the lien for homeowner dues placed against the property — and has received a court summons.
“Sue” has also been taken to court after withholding her dues because the association did not make repairs she believes they were required to make.
All of these readers are facing severe negative items on their credit reports that can significantly drop their credit scores.
What can HOA members do to protect themselves?
First, understand that dues typically don’t show up on credit reports unless there is a problem. Mike Hunter with Horack Talley in Charlotte, North Carolina, represents more than 500 HOAs in that state. He says, “None of the HOAs I represent nor their management companies report debts to the credit bureaus. The only way they could show up is if a lien, foreclosure or judgment is filed. The reporting agencies have people that comb the public records for this information, and that’s the only way it can show up in a homeowner’s credit report.”
How to avoid credit damage: Having trouble paying your dues? “Try to make a payment arrangement with the HOA to get you caught up,” suggests Mike Boyd who has been the president of his HOA for 13 years. “It’s also best to do this before your account is sent to the HOA’s attorney for collection, because as soon as that happens you will also be liable to pay all the attorney’s fees and expenses for handling this matter,” he says.
Take this obligation seriously. Don’t assume that just because you are delivering the check to someone in your neighborhood that you can let it slide if you’re short on money that month. “HOA obligations due on a property are legally binding promises that are enforceable under the law,” warns Matthew Reischer, Esq., CEO of LegalAdvice.com. “HOA collections can result in assessments, interest, violations, late fees and fines. The debt owed can also result in a lien on the property or be a basis for wage garnishment proceedings,” he adds.
And before you buy a home within one of these communities, make sure you read and understand the deed restrictions. “If you paint your house, you had better pick exactly the right color if you live in a home that is subject to a homeowners’ association. If you are late on your assessments, you may find yourself out of a home,” warns Kenneth G. Eade, an attorney who has seen both of those situations and plans to incorporate those kinds of problems in his next novel in the Brent Marks Legal Thriller Series. “These (battles) have diverted the income that my clients could have used to remedy these petty problems when HOA busybodies would rather litigate to get their way than to compromise.”
“Does it affect your credit rating?” he asks. “That and all other aspects of your financial life!”
With home values rising, more Americans have equity in their homes. That has generated plenty of cheers from homeowners, and it’s also brought back the home equity line of credit as a popular option for the first time since before the Great Recession. Americans took out $23.4 billion in home equity lines in the first quarter of 2014, up 15.5 percent from 2013 and the highest number in six years, according to Equifax, a credit reporting agency.
If your mortgage is less than 80 percent of your home’s value, you might want to join that group. But the greatest lesson of the recent real estate boom and bust is that turning home equity into cash is
“Equity is really an ethereal thing. In a sense, it’s not real.”
best done with great care. “The mortgage mess and the real estate recession gave us some really good lessons in how home equity lending could go bad,” says Liz Weston, a personal finance columnist and author of “Deal with Your Debt: Free Yourself from What You Owe,” and other books. She cited a 2011 CoreLogic study that found that borrowers with home equity loans or lines of credit were significantly more likely to owe a larger amount than their homes were worth.
“We shouldn’t forget those lessons now that many people have equity again, and that banks are allowing us to tap it. Your home equity is a precious resource that shouldn’t be squandered,” Weston says.
There are times that having a home equity line of credit is a smart financial move. It’s hard to find a loan at better rates — less than 4 percent for borrowers with good credit — and qualifying for a home equity line of credit is easier than it is for a business or personal loan. Having a home equity line of credit but using very little of it can help prepare for emergencies, Weston says.
“Even a fat emergency fund can get drained by a big-enough financial setback, and most people don’t have a fat emergency fund,” she says. “The key, though, is, again, not to squander that equity. You want it there for you when you need it. If you’re such a spendaholic that you can’t trust yourself not to use the line, then of course you shouldn’t set one up.”
Using home equity line of credits to finance cars and vacations is generally a bad idea, financial experts say. Using the line to fund a child’s education might be a good idea, but only if you can pay it back in five to 10 years.
“I think what we learned with the last housing boom is that there’s a danger in tapping home equity,” says Daren Blomquist, vice president at RealtyTrac, which tracks and analyzes housing data. “That equity is really an ethereal thing. In a sense, it’s not real.”
Property values have risen significantly in the last few years, which has added to Americans’ home equity, but while home values have increased, the pace of growth is now slowing, he says. “You have to be careful you’re not treating that home equity as an unlimited source of funds,” Blomquist says.
The safest use of home equity funds is for home improvements that will add to the home’s value. If you spend $50,000 on a home addition that adds $50,000 to your home’s value, you’ve broken even — though you still have to make payments on the money you borrowed.
During the real estate boom, many investors, and even some individual homeowners, drew on their home equity to buy additional properties, keeping these properties heavily mortgaged. When home values dropped, many investors lost all their properties due to the risky real estate game they were playing. “Leverage can be an amazing tool for an investor, but it can also be an entirely dangerous
There are actually three ways to draw on your home equity.
tool as well,” Blomquist says.
If the only funds you have to draw on for investment are your home equity, you may want to reconsider, Weston says. “Home equity lines can be a cheap source of credit, but you’re putting your home at serious risk,” she says. “The only way it makes sense to me to borrow to invest is if you have enough savings to pay off the debt in a hurry if you have to.”
There are actually three ways to draw on your home equity: Do a cash-out refinance, take out a home equity loan or get a home equity line of credit. In all three cases, most lenders won’t let you borrow more than 80 percent of your home’s value.
Refinancing restarts the home mortgage clock and has higher costs but low interest rates, currently about 4.12 percent for a 30-year, fixed-rate loan. A home equity loan, sometimes called a second mortgage, usually has a fixed rate (Bankrate.com listed rates from 3.24 to 8.99 percent for a $30,000 loan) and a set time to pay it back, generally with equal monthly payments
A home equity line of credit is more like a credit card. The lender sets a maximum you can borrow, and you can draw money as you need it, though many home equity line of credits require an initial draw. The interest rate varies daily, and is usually prime plus a set number, but the required payment is usually interest only.
After a certain number of years, the line of credit converts to a home equity loan, principal becomes due and you can no longer draw on it. The current interest rate starts at less than 4 percent, but that is likely to increase as the prime rate — which has been 3.24 percent for the last year — rises.
Here are five questions to ask yourself when considering whether a home equity line of credit is right for you:
Do you need money to fix up your home? If you’re planning to sell soon, a home equity line of credit may be the best way to finance improvements, and you can pay it off entirely when you sell. Using a home equity line of credit may also be a good way to finance improvements if you plan to stay in the house, but make sure you’re not still paying off this year’s paint job when it’s time to paint again. “It’s a great time to consider renovations, either to improve the quality of life you’re experiencing yourself or to improve the potential resale value of that home down the road,” Blomquist says.
Do you need a new car? Look for an auto loan from your bank or a credit union instead. Rates are comparable, and you won’t put your home at risk if you fail to make the payments.
Do you want to consolidate credit card debt? The big question to ask yourself is whether you’re likely to go into debt again. Using your home equity to pay routine bills is not financially smart. But if your credit card debt is at high rates and was incurred because of a setback you’ve now recovered from — such as unemployment or serious illness — a home equity line of credit might be a way to pay less interest. However, if you don’t pay credit card bills, you still have your home. If you can’t make your equity line payments, your home is at risk.
A home equity line might be a good idea if you anticipate having an increase in income that will enable you to pay off the debt quickly. However, if you’re nearing retirement, your mortgage balance is high and your income is declining, you might be better off encouraging your child to take out his or her own student loans.
Are you starting a business? A home equity line of credit might be a good way to raise needed capital. But before you put your home at risk, make sure you’ll be able to pay off the debt if your business fails.
Sometimes paying your bill the wrong way — or in this case, trusting that an ex-spouse will get it right — can torpedo a good credit score, as one reader found out. Here’s her story:
I have been divorced for 6 years, and my ex-husband kept the house that we lived in. He has made all house payments on time in the last 6 years. When he got down to a small amount being owed ($188) on the small loan of our 80/20 split mortgage, he sent in a check for the final amount — Not knowing there was a rule of making a final payment with a cashier’s check in lieu of a personal check. The mortgage company eventually returned the check and advised him of the same, however by then the mortgage payment was late. This resulted in them reporting this on both of our credit [reports], dropping [my score] 150 points. The error has since been resolved and the total loan amount is paid in full, however they are refusing to remove this from my credit report. I understand the whole “my name is on the loan” reasoning, and I don’t disagree with it, however this was an honest error on an otherwise spotless credit history on my part . . . . I have disputed it with the credit agencies, disputed it in writing with the mortgage company, but am looking for any advice to repair my credit score that has dropped from 780s to 600s?
The drop in her score, from the “excellent” range to “poor/fair” territory, as a result of just one late bill, illustrates the impact that a single misstep can have on an excellent score. The good news here is that if she has other credit accounts, she won’t have trouble adding positive information to her credit reports, and those will help dilute the impact of the negative mark. So will time. The further this recedes into the past, the less impact it will have. (Our reader can and should check her scores regularly to track her progress. Credit.com offers two credit scores every 30 days for free.) Her best bet at this point is to pay bills on time and to make sure her balances aren’t higher than 20 percent to 25 percent of her credit limits.
Though she is doing all the right things, it’s frustrating that one slip-up would hurt her credit score that much.
Unfortunately, the mortgage company is uninterested in helping and that doesn’t leave her with many good options. Kristine Snyder, a public relations representative at Experian — one of the three major credit bureaus — said one option might be to include a statement in her credit report explaining what happened. But it won’t help her credit scores, as statements aren’t factored into them.
Our reader may want to try to appeal to someone higher up at the mortgage company, going as far as an executive office if need be. “It certainly wouldn’t be inaccurate for them to report the payment received on the date they received the personal check,” says Steve Rhode, founder of GetOutOfDebt.org.
Other than that, it’s a case of knowing, with perfect hindsight, what she wished she’d done — separated finances entirely at the time of divorce or wishing her former husband had paid with a cashier’s check. But if a do-over is impossible, revisiting it won’t help, so all she can do is start where she is now. But the good habits that helped her build a good credit score in the first place will help her rebound.