If you’re hoping to purchase a home soon, there’s plenty of items to concentrate on. Your loan officer or realtor will probably give you a list of the documents you’ll need, and some “to do” items, like check on homeowner’s insurance and save your paystubs.
Getting a mortgage, however, isn’t just about the “do’s”. Committing any of these “don’ts” can easily prevent you from being approved, whether you’re planning to buy a house in the coming months or are in the process now. Don’t let these “don’ts” cost you your new home!
1) Switching from an employee to a self-employed position:
The requirements to verify salaried/hourly employees’ income are straightforward: W2’s and paystubs are often all that’s required. Changing jobs, particularly if in the same field with salaried income, isn’t an automatic deal killer. Transitioning from an employee to self-employment (aka contractor or “being paid by 1099”) is an entirely different matter. Self-employed borrowers’ incomes are documented not by recent paystubs, but by IRS verified tax returns for the prior year (or two). An employed borrower who could easily obtain a mortgage today will likely have to wait 2+ years to qualify if he becomes self-employed! Consult your lender BEFORE you consider any employment changes, particularly if self-employment is involved. Don’t quit your day job to become a Grubhub driver!
2) Not balancing your checkbook:
You may regard overdraft fees as mere inconveniences that “just happen”. Your lender, however, likely views them as financial irresponsibility. Some loan programs require underwriters to review applicants with overdrafts more stringently than those without, regardless of credit scores or debt ratios. If your recent bank statements have overdraft fees, tell your lender UPFRONT, rather than hoping they don’t notice. They will!
3) Applying for new credit and opening accounts during the loan process:
Transferring a $9,000 credit card balance at 16% interest to a new, 0% account will lower your payment and help you qualify for the loan, right? Not so much! By making moves like this during the loan process, you’re risking closing delays, perhaps even your loan approval. Purchasing a new car before closing your mortgage (even after the mortgage is approved!) may cost you your house. Lenders monitor your credit for new inquiries and accounts during the loan process. Any new accounts must be verified, then added to debt ratio calculations. Unless you plan to live in your car, buy it AFTER you’re in your new home.
4) Ignoring small bills:
“My insurance was supposed to pay that bill, it was only $30!”, “I closed that credit card, but they still sent me another bill, so I just ignored it”, “I missed the payment cutoff, and they added a late fee, so I just paid double the next month”. These may seem like trivial matters to you, but credit bureaus view them far differently. Even with flawless credit, a small collection or late payment (even on a $25 credit card bill!) can drop your credit scores dramatically. Don’t endanger your loan approval: pay all your bills promptly, whether you think they’re fair or not!
5) Not filing tax returns:
Taxes are a pain, right? You can always do them later, or maybe the IRS won’t notice! Guess what? They will, and so will your lender. Lenders typically verify applicants’ income with IRS tax transcripts. If you haven’t filed, there’s no transcripts, and you may have just lost that new house. Filed a tax extension? That’s OK, if you paid any estimated taxes due. Filed a tax extension, missed the extended filing date, so decided to wait until you need a mortgage to file? Not OK, not at all!
There are other obscure ways to jeopardize your financing, but remember, when in doubt, ask your lender BEFORE you quit your job, buy a new car, bounce some checks, or fall behind on bills!
Other Reasons Why You Might Not Get a Mortgage
6) You have ownership in other properties:
Do you hold an ownership share in other homes, perhaps your parents’ or children’s? If so (whether you live in those homes or not), the expenses associated with those homes (mortgage payment, taxes, insurance, HOA costs) may impact your DTI (debt to income ratios). At a minimum, your underwriter will request documentation on your ownership and proof of who is paying the mortgage. If you’re a co-signer and can document the costs have been faithfully paid by the occupant homeowner, the expenses MAY be omitted from your debt ratios. Typically, underwriters want to see 12 months documentation of the occupant owner making the payments in a timely fashion. If you co-signed for your son and he paid the mortgage late, or the property was purchased recently and no payment history can be collaborated, you’ll likely need to qualify with the full expense of that property in your debt ratios. After all, as a co-signer you ARE responsible for that payment, right? Parents who co-sign for their children’s student loans fall into this same situation.
7) You’re self-employed, and your business tax returns show declining income:
Self-employed borrowers faced myriad loan approval challenges during Covid (and still do!) if their business income dropped from preceding years, particularly if it dropped dramatically. After all, it’s tough to justify using a 2 or 3-year income average if the most recent net income on your tax return is less than prior years’ income. Income decreases of 20%+ are often considered unacceptable, unless mitigating circumstances (such as one time business expenses) can be documented. If you’re self-employed, be sure your loan officer has your business and personal tax returns and discuss how your income has changed over the past three years. Be prepared to complete an accurate current year P&L statement for your business, hopefully showing net business income on pace with last year’s, or at least close to it. Note, it is critical to address this PRIOR to writing a sales contract. The last thing you want is to go under contract on your dream home, only to find out your income declined and is insufficient for loan approval! For complex income or credit scenarios, ask your lender if your loan can be submitted as a TBD, meaning an underwriter examines your credit, income, and other qualifications without designating a specific property, using estimates for the purchase price, interest rate, loan size, taxes, etc. Which brings us to…….
8) Your “pre-approval” isn’t worth the paper it’s written on:
While we’ve previously discussed the various types of pre-approvals, let’s review this important topic! Lenders handle pre-approvals several different ways. Some allow loan officers to issue them without examining income or asset documentation, simply asking clients “how much do you make” and “how much do you have in liquid assets”. As you can imagine, this is NOT a sound strategy. A pre-approval issued without documenting the prospective borrower’s income and asset documentation is like throwing spaghetti at the wall to see if it sticks.
Other lenders may ask for income/asset documentation, then generate pre-approval letters without running the prospective buyer through an automated underwriting system (aka “AUS”). This means the pre-approval is based on the loan officer’s belief the loan will pass underwriting scrutiny. This may well work, until it doesn’t. Even the most veteran loan officer has run into loans he was SURE would pass AUS that didn’t! Automated underwriting systems can pick up significant credit concerns that aren’t apparent on credit reports, including prior foreclosures or judgments. Issuing a pre-approval without first obtaining an AUS approval is common but means there’s still a chance that the pre-approval is inaccurate.
The GOLD STANDARD of pre-approvals is (you guessed it!) an actual pre-approval, meaning an underwriter has reviewed credit, income, and asset documentation, run the loan through AUS, and has formally approved it, subject to assumptions such as purchase price, the loan’s interest rate, and the cost of property taxes/homeowners insurance/HOA fees. If the actual details of the transaction fall within the assumed ranges, the approval is accurate. If (as they typically do) the actual taxes/insurance/HOA vary from initial estimates, your underwriter will rerun AUS to ensure the loan still qualifies. Savvy underwriters initially estimate tax/insurance costs on the high side to be safe. We’ll talk more about this in the future, but a sales offer accompanied by an actual underwriting approval is far stronger than a vague, generic pre-qualification letter that states “subject to income/asset documentation and underwriting review.” A buyer with an underwriting approval in hand (from home sellers and agents’ views) is the next best thing to a cash buyer. The sellers and agents can be assured there won’t be an issue qualifying for the loan, since the buyer has already done that!
9) Rates rise from the time your pre-approval is issued until you go under contract on a specific home:
In today’s wildly volatile rate environment, it’s tough to know how rates will change tomorrow, let alone a few weeks from now. Lenders assume an interest rate when they run an AUS approval. If the assumed rate is too low, a borrower’s debt ratios may be inaccurate, leading to a loan denial when the rate is corrected.
This sounds problematic, you say? Indeed, it can be, which is why prudent lenders base their pre-approvals on interest rates higher than current rates. Here’s an example: You’re buying a $500K house, putting 20% down. Current rates are 7.25%, and your lender bases your pre-approval on that rate, including the loan payment of $2728 in your debt ratios. By the time you find a suitable house and go under contract, rates have risen to 7.5%, raising your payment by $68 over the pre-approval’s estimate. While you may or may not consider a $68 payment increase significant, if your debt ratios were already high, that $68 might put them above acceptable ranges, endangering your loan.
That’s why responsible lenders “build some wiggle room” into their pre-approvals, using interest rates somewhat above current levels. This means all parties are protected and the transaction should close as planned, even if rates rise before a property is identified and the rate locked, especially on new construction loans (where the contract may be written a year or more before the home will actually be completed).
If your lender supplies a pre-approval showing a rate higher than you expected, it doesn’t mean your mortgage will have the higher rate, it simply means you qualified with it. Ask your loan officer if your pre-approval shows the actual current rate for your loan scenario, or is higher, to ensure you’ll still qualify if rates rise. If “Lender A” gives you a pre-approval at 7% and “Lender B” provides one at 7.5%, it doesn’t necessarily mean Lender B’s rate is actually higher, just that the pre-approval is based on a 7.5% rate!
10) You’re buying a “white elephant”:
That custom earth home, on 150 acres, with no furnace, no electricity, a well 100 yards from the house for water, and a private access road with no defined maintenance agreement MIGHT be just what you’re looking for (at least if you aspire to be a hermit). If you’re paying cash, you can certainly purchase any home within your budget. If you’re utilizing a mortgage, however, the property must meet minimum agency requirements for items like heating system, water, and the home’s value compared with the land’s.
Appraisals break down the value of “improvements” ie: home and outbuildings compared with the land value, and the bulk of the total value needs to be the improvements. A single wide manufactured home, valued at 50K on a plot of land valued at 100K almost certainly won’t meet lender approval, the land is worth more than the home! In addition, appraisal values are determined by examining recent “comparable properties” sales’ prices. If you’re buying the only earth home within a 200-mile radius, there’s no comparable properties!
If your dream home is unusual or unique, discuss it with your loan officer PRIOR to writing an offer, even if you have an official TBD underwriting approval. After all, the presumption of that approval is that the home being purchased meets all agency guidelines!
Thanks for reading today’s edition. Our veteran loan officers and support staff want you to understand your mortgage approval, avoid surprises during the homebuying process, and ensure you don’t lose sleep wondering whether your loan will close as planned. It’s far more fun to concentrate on picking out furniture and blinds for your new home (without incurring new debt prior to closing!) rather than stress about your mortgage!