The Mortgage Porter

Your write-offs may impact qualifying for a mortgage

From my email bag:

My husband and I are in the process of looking for a lender we are negotiating an offer at this time. We are both paid with W2-s and fear that we will be asked for our tax returns since we have plenty of write-offs as we are in sales. In this case, will the lender look at our adjusted income on our tax forms instead of the yearly salary?  

The lender will most likely have to use a net-income when you have significant write-offs on your tax returns. Since you're in sales, depending on how you are paid (for example, if you're paid commission) the lender may request your income tax returns due to this very example.  

Even if you're paid an annual salary, the 4506T that lenders use on transactions to obtain tax transcripts from the IRS will reveal your write-offs and the lender will most likely require your tax returns and make the appropriate adjustments to your income. This is also true when qualifying for a refinance.

When you're completing your tax returns, you may want to keep in mind that what you report to Uncle Sam is also what the lender will be viewing when you're obtaining a mortgage.  Self-employed borrowers who appear to make little income on their tax returns may also find themselves being impacted with how large of a mortgage they will or will not qualify for.

Remember, I'm not a CPA nor a tax expert. I do specialize in originating mortgages for homes located anywhere in Washington. I have been a licensed mortgage originator since January 1, 2007 and have been at Mortgage Master Service Corporation since April 1, 2000. If I can help you with your home purchase in Seattle or your refinance in Redmond, or anywhere in Washington, please contact me.

Explaining the "Letter of Explanation"

It's not unusual these days to have a lender request a "letter of explanation" from a home buyer or someone who is refinancing their current property.  I letter of explanation (or LOE) is often used to help provide more information to the underwriter or lender based on information that is disclosed on an application or credit report. LOE's may address anything from gaps in employment to inquires on a credit report and is intended to help explain or add support to the transaction. If a borrower has had an extenuating circumstance and is trying to have an exception made to an underwriting guideline, they may be asked to write a LOE.

When a borrower is asked to write a letter of explanation, they need to address what the situation was, why it happened and possibly, what has been done to improve the situation.  For example, if someone was unemployed for a while or had their income reduced. If you've had your credit checked in the last 120 days, be prepared to provide an LOE addressing each inquiry. The lender needs to know what the inquiry was for and if a new debt was incurred from each inquiry.

Sometimes lenders will require a letter to explain one's motivation for buying. This may sound silly to you, this is because of past cases of fraud, typically those involving occupancy. This request may be triggered when someone buys a smaller home than what they currently own as owner occupied or buying another home that is nearby (within 50 miles) of their current residence that they own. These circumstances can raise a red flag to an underwriter and if the property and transaction appear to be more fitting as an investment property than a primary residence, the underwriter may still want to treat the transaction as an investment regardless of how strong the letter is.

When you write a letter of explanation, consider that you are essentially writing this to the underwriter and your goal is to present a good case of why you should be approved for a mortgage. Be truthful, thoughtful, keep to the point and if you have any documents that may support your scenario, you may want to include it.  Letters of explanation are not an uncommon request in today's mortgage climate. 

Buying Your First Investment Property

With real estate becoming more affordable and mortgage interest rates at an historic low, it's easy to see why some people are considering buying their first investment property.  Financing an investment property has more requirements to it than buying an owner occupied property because it carries more risk to the lender. However if you have enough income, plenty of reserves set aside and good credit, you may be surprised how easy the process can be and what programs are available.  

"Traditional" Conventional Financing. 

Plan on at least 20% down payment and know that the more you are able to use as a down payment, the better your interest rate may be. With your down payment, the funds must only be your "seasoned" funds, they cannot be a gift.  The seller may contribute up to 2% towards closing cost and prepaids.  You *might* be able to have a second mortgage (seller financing, for example) up to 85% combined loan to value however, be prepared for a round of extra scrutiny from underwriting.

Just like buying your primary residence, your credit score will impact your mortgage rate. You don't have to have 740+ scores, some lenders will go down to a 620 score however be prepared to be scrutinized.  There are price breaks with interest rates based on a 75% and 70% or lower loan to value.  

In addition to the down payment and closing cost, conventional guidelines on investment properties requires six months reserves (your total proposed mortgage payment including any home owners association dues x 6) in savings at the end of the transaction.  If those reserves are your retirement or stock, lenders will discount them to 60 or 70% of the ending balance shown on your statement.  Additional properties owned will require additional reserves, for example, if you own a vacation home, an additional 2 months reserves will be required.

A typical debt to income ratio is 45% and as a first time landlord, you will need to qualify with both mortgage payments (no credit for rent).

Click here if you would like a rate quote for a investment property located in Washington.

Special programs.

Fannie Mae Homepath.  Fannie Mae Homepath Mortgage will allow for as little as 10% down payment on designated Homepath properties (owned by Fannie Mae) with credit scores of at least 660.  There is no appraisal required and no mortgage insurance with credit scores of 660 or higher.  I've written more the Fannie Mae Homepath program for investment properties here.

FHA. If you are getting ready to buy your first home, did you know that you can buy a 2-4 unit property (duplex - fourplex) using an FHA insured mortgage with owner occupied rates?  You DO have to occupy one of the units. Financing a duplex is very similar to buying a 1-unit home as far as underwriting requirements are concerned. When you step up to a 3-4 plex, the reserves requirements are increased to three months.  When buying a 2-4 plex home that you're going to occupy using FHA for your financing, you receive competitive rates (owner occupied because you are occupying one of the units) with minimum down payment.  Plus projected rents may be used for qualifying!  As with buying a single unit home with an FHA mortgage, upfront mortgage insurance (can be paid as a closing cost or financed) and monthly mortgage insurance do apply.

Click here for more articles I've written about financing residental investment property.

If you're interested in buying your first rental on a home located anywhere in Washington, including Renton, Redmond, Seattle or Snoqualmie, please contact me. I've been originating mortgages since 2000 at Mortgage Master Service Corporation and have all the programs mentioned above.

Please click here if you would like me to provide you with a rate quote for property located in Washington.

My thoughts on NAR's Pending Home Sales for April: Mortgage Guidelines are NOT "Excessively Tight"

This morning NAR released the Pending Home Sales report which revealed that "contract signings, dropped 11.6 percent in April from a downwardly revised 92.6 in March. The index is 26.5 percent below a cyclical peak of 111.5 in April 2010 when buyers were rushing to beat the contract deadline for the home buyer tax credit." Pending home sales is a forward indicator since it's reporting on contracts that are signed but not yet closed.

Lawrence Yun, NAR's Chief Economist states that part of reason for the larger than expected drop is due to how difficult it has become to obtain a mortgage. 

“No doubt the continuing excessively tight mortgage underwriting process is making the housing market recovery unnecessarily slow...We simply have to get back to sound, common-sense lending standards to provide mortgages to creditworthy borrowers who are buying homes well within their means. Bank balance sheets show rising cash reserves and declining loan balances – it’s time to loosen the purse strings....” 

It's my experience that it's not that difficult to obtain a mortgage and underwriting guidelines are not "excessively tight".  The difference between qualifying for a mortgage now and pre-2007 is that borrowers must now prove (provide supporting documentation) that they meet program guidelines.  Stated income, low or no-doc loans are gone.  

• Every penny of your down payment and funds for closing must be documented with complete bank statements (all pages) or other asset accounts being used.
• Large deposits on your bank statements must be sourced (more documentation) to show where the funds came from.
• Employment must be steady.  Buyers are not required to have been on the same job for the past two years...heck, they can be out of college (may count as employment) and there may be some unemployment periods...it needs to make sense and be documented.
• Income must be steady.  If a potential borrower is not paid salary (hourly, commission, bonus, self-employed, etc.) they need to show they've received this type of income for the past two years.
• Borrowers must be able to afford their home based on their income and debts. Some debts where payments are deferred, like student loans, are factored into your debt-to-income ratios...one day, you are going to have to make payments on it!  
• Borrowers who take out new debts before funding (closing) of their loan, may find they no longer qualify for their mortgage.  Doesn't this make sense? Yes, home buyers may need new a washer and dryer...however if they're borderline with their credit or pushed with their qualifying ratios, they risk blowing up the purchase just before closing due to "LQI".  Home buyers need to make sure they honestly reflect the loan application from the start of the transaction to finish.

Okay, I'll admit that credit scoring has become tougher. Pre-2007, a person with 600 credit scores (or lower) could qualify for a mortgage.  Now you pretty much need a mid-credit score of 630 or higher for most loan programs.  And their are price hits (risked based pricing) that are factored into interest rates based on loan to value and credit scores.  Credit scores are reflective and borrowers can work on improving their credit scores (and should).  

Income is also scrutinized more than before with 4506Ts being required on every transaction. If your income is higher on your loan application than what you claim on your tax returns, be prepared...you'll be providing additional documentation (tax returns) even if you're paid a salary and your income may be adjusted lower.

Here's where Congress may really muck up the housing recovery, especially in light of this report:

• Lowering the conforming loan limits, which is scheduled to happen on October 1, 2011.  In the Seattle area, the current conforming loan limit is $567,500.  Effective October 1, 2011, it's set to roll back to $506,000 meaning that loan amounts of $506,001 or higher will be "jumbo" non-conforming.  Jumbo loans have much tougher guidelines and higher rates which does mean that fewer people will qualify for higher priced homes.  Loan limits are also set to be reduced for FHA and VA loans after September 30, 2011.  By the way, 2012 loan limits may be even lower!
• Increasing the minimum down payment for FHA loans from 3.5% to 5%. Congress is working on this right now and it's been tossed around by our government for quite a while.  Does having 1.5% more "skin" in the game really make a more responsible borrower?  I don't think so.  I would rather see that a borrower have that 1.5% in their savings than invested as down payment (where they do not have access to it should they have an emergency) in a home.

People can still get a mortgage today.  It bothers me that NAR and others are painting that mortgages are too tough to obtain...painting an inaccurate picture does not help the housing market either.  Today's buyer needs to be prepared to provide plenty of paperwork to support they actually qualify for the mortgage by showing they earn what they say, have the funds for closing and are employed.  What's wrong with that?

If you are considering buying a home, I do recommend meeting with a local licensed mortgage professional as early as possible to start on the prequalification process.  If your next home is located anywhere in Washington State, I'm happy to help you!  

PS: I still believe that it would tremendously help the housing markets recover IF home owners who want to refinance and who qualify based on credit, income and employment are allowed to without an appraisal...very similar to an FHA streamline refi. This would allow people who want to stay in their homes and who qualify, to be able to take advantage of today's lower rates and not cause them to be punished due to lower appraised values.

How much can Sellers contribute towards Closing Cost?

If negotiated in your purchase and sales agreement, a Seller may agree to chip in towards some or all of your bona fide closing costs, prepaids and reserves.  They cannot contribute towards your down payment.  The amount the seller can contribute varies depending on the program type and the amount of home buyer's down payment. The percentage is based on the sales price and if the credit exceeds the closing cost, the mortgage originator can often use it towards discount points to buy down the interest rate. 

Conventional: Fannie Mae/Freddie Mac - Owner Occupied

• 25% or more down payment = 9% allowed seller contribution
• less than 25% down and up to 10% down payment = 6% allowed seller contribution
• less than 10% down payment = 3% allowed seller contribution
• Fannie Mae Homepath:  less than 25% down = 6% allowed contributions; 25% down or more = 9% allowed contributions

Conventional: Fannie Mae/Freddie Mac - Second Home

• 25% or more down payment = 9% allowed seller contribution
• less than 25% down and up to 10% down payment = 6% allowed seller contribution

Conventional: Fannie Mae/Freddie Mac - Non-Owner Occupied/Investment (including Fannie Mae Homepath)

• 2% maximum seller contribution

FHA:

• 6% maximum seller contribution.  Seller contributions CAN include the upfront mortgage insurance premium.  NOTE:  There has been a lot of rumbling that the seller contribution is going to be reduced.  This has not happened as of this post.

VA:

• 4% closing cost contribution and an additional possible 4% sales concession (i.e. paying off debts)

USDA:

• No limit to how much sellers can contribute (is limited by actual closing costs/prepaids).   NOTE: When a home appraises higher than the sales price, closing costs can be financed with USDA rural loans up to the difference between the sales price and appraised value.

It's very important that you let your mortgage originator know if you're working with a seller contribution (or any contribution) towards closing cost.  It's also a good idea to have your real estate agent contact your mortgage originator before presenting an offer so that everyone is on the "same page" with the contributions that are potentially being proposed in a real estate transaction.  

The only time I've seen issues with closing costs contributions is when it has not been communicated to the the lender.  Contributions from real estate agents towards closing costs are treated the same as a seller contribution so it may be possible to have "too much credit".   When this happens, contributions are treated as sales concessions which is a different animal than a seller contribution.

Also be aware that some lenders may have their own guidelines (underwriting overlays) that reduce or impact the allowed contribution limits stated above. 

If you're considering buying a home anywhere in Washington, I'm happy to help you. Click here for your free rate quote.

Income Limits and Property Qualifications for USDA Rural Loans

NOTE: USDA INCOME LIMITS HAVE BEEN UPDATED SINCE THIS POST WAS PUBLISHED.

USDA is a government backed program that allows zero down payment on homes that are in a designated rural community for families earning less than a certain income.  A majority of Washington State single family residences (homes and condos) qualify...of course if you live in metropolitan areas like Seattle or Bellevue, odds are your home will not.   To qualify, families must be without "adequate housing" (may not own a home or adequate home), must have reasonable credit history and be able to afford the mortgage (29/41 is the debt to income ratio guidelines).  I've written more details about USDA home loans on this earlier post.

Income limits vary by county and the entire household income is considered (not just the primary borrowers or those borrowers on the mortgage) for determining if the income meets the guidelines.  This is separate from income considered for "debt-to-income" ratios.  USDA loans allow incomes up to 115% of the median income for the area.  Income limits vary on household size from 1-4 person or 5-8 person.

As of the publishing of this article, in Washington, the income limits by county are:

• King and Snohomish Counties: 1-4 Person $92,600 | 5-8 Person $122,250
• Island County: 1-4 Person $89,550 | 5-8 Person $118,200
• Clark, Kitsap and Thurston Counties:  1-4 Person $82,650 | 5-8 Person $109,100
• Pierce County:  1-4 Person $80,050 | 5-8 Person $105,650
• All other Washington counties:  1-4 Person $74,050 | 5-8 Person $97,750

You can check current USDA income limits by visiting the USDA site (clicking here)...be sure to click the "guaranteed" option.   Income limits can and do change.  You can also use USDA's income eligibility calculator which will factor in deductions to income.  You're looking for the "guaranteed" results and not "direct".

Income used to determine if a family is under the household income limits includes all those (18 years and older) who will be living in the home regardless of whether or not they're on the mortgage.  Incomes of children over 18 who working AND who are full time students are not factored.

Once you've determined that you meet the household income limits, the next step is to see to see what communities in your area are eligible for USDA financing.  You don't have to go too far from Seattle or Bellevue to find homes that do qualify for this type of mortgage.   Using the USDA site, under "Property Eligibility" click "Single Family Dwelling".  From there you can either enter a specific address or click on the map to narrow down your search. 

Sellers and real estate agents who are working in neighborhoods that qualify should be sure to include this program as an option they'll consider for financing on their offers. 

I'm pleased to offer USDA financing as an option for borrowers who meet the criteria since there is no private mortgage insurance and the program is a 30 year fixed rate. If you have any questions regarding USDA or other mortgage programs for financing homes located anywhere in Washington State, please contact me, I'm happy to help!

A Qualifying Comparison Between 30 Year and 15 Year Fixed Rate Mortgages

Betty Bellevue is interested in seeing how much home she can afford to buy.  She has excellent credit (her middle score is above 740) and she has $250,000 set aside for her down payment and closing cost.   The maximum mortgage payment she feels comfortable with is $3850 including property taxes and home owners insurance.   

Using a mortgage amortized for 15 years would allow Betty to qualify for a loan amount of $417,000 with an interest rate of 3.875% (apr 4.123).  With her down payment and closing cost of just under $250,000, she could purchase a home with a sales price of up to $650,000.

If she decided that she would like to buy a home with a higher price, she could opt for a 30 year fixed rate.   The same PITI payment of $3850, Betty qualifies for a loan amount of $567,500 based on the current mortgage rate of 4.75% (apr 4.866).  Factoring down payment and closing cost of $250,000, the maximum sales price she could consider based on these terms is $800,000.  

Which ever mortgage Betty Bellevue decides on is completely her choice.  The payments are essentially the same.   She can also always pay additional towards her principal with either scenario without penalty to pay her balance down quicker.  

Side note:  $567,500 happens to be the current conforming high balance loan limit for homes located in King, Pierce and Snohomish counties through September 30, 2011. Any amount over $567,500 would be considered a jumbo/non-conforming mortgage and would have a higher rate and different underwriting guidelines.

Calculating Bonus Income

Here's a question from one of my readers (not one of my clients) regarding how bonus income is treated for qualifying for a mortgage:

I am trying to close on a property and the loan processor is giving me a hard time about my income.  I am suppose to make $53,000 this year.  Last year I made $50,000 according to my W2.  My base salary is locked at $32,000 with the other income being a commission or bonus based off my offices profit.

Currently the loan processor is taking my year to date bonus/commission and dividing it by 12.  She is stating that this is how they are the bonus income is annualized so it is making it seem like my projected income for the year will be 32,000 + approx 5,000 = 37,000.  This is making my income to debt ratio pretty low.  Do you have any advice on how I can get this adjusted or if this is actually the correct way my income should be calculated?

Lenders are looking for trends with income.  Since your base income is a salary, the processor can give you credit for the entire amount.  If your additional income is bonus or commission, then lenders may go back 24 months to create an average bonus/commission income.  If your income is trending lower, best case--the lender may use the current average for your commission/bonus income.  Lenders are looking for "stable" income...if the income is considered unstable, there may be issues.

Most lenders will typically go back 24 months including year to date bonus income; and average it since this type of income fluctuates and is not a guaranteed fixed amount.   Hopefully your bonus income in 2009 is close to what your 2010 bonus income was and shows a positive income trend.  You need to document that you've been receiving your bonus income for a minimum of two years.   

2009 = $20,000 Bonus Income

2010 = $23,000 Bonus Income

3/31/11 = $5,000 Bonus Income

$48,000 divided by 27 (24 plus 3 months) = $1778 monthly bonus income.

If the base salary is $32,000; your loan application will reflect base monthly gross income of $2667. (32k divided by 12 months).  Even if the base salary was lower in previous years, the current base (assuming it's a bona fide salary) is what is used to determine current monthly income for qualifying for a mortgage.

$2667 plus $1778 = $4,445 averaged monthly income (based on the example above).

Another factor to keep in mind is that lenders will pull 4506 Request for Tax Transcripts so if you write-off significant amounts of your business expenses, this may deducted from what the lender uses for your income. 

Verification of Employment forms (VOE) will be sent to your employer to verify that your bonus is likely to continue.  If your lender is relying on a Verification of Employment for your bonus income, they may annualized it (divide the current year to date amount by 12 months) instead of using an average.  Plus, if your employer indicates that the bonus income is not likely to continue, it should not be used for qualifying purposes. 

Dear Reader:

It appears to me that the processor is "annualizing" your bonus income ($5000 divided by 12 = $417) instead of averaging.

Talk to your mortgage originator about supply documentation (last two years tax returns, W2s and/or 1099s) to support your income to see if this will change how the processor is calculating your income.   

Good luck!

5 Ways to Derail Your Loan Approval

You're getting ready to buy a home or refinance your home with your closing day around the corner when your mortgage originator contacts you to let you know there may be a problem.  Some issues may not revealed until days or sometimes weeks into a transaction.  Anytime documentation is provided to the mortgage company, it has the potential to raise more questions or require more documentation to satisfy underwriting guidelines.   Here are five situations to be aware of that can cause headaches during the loan process.

Not disclosing all information on your application.  It could be very innocent, you forget to mention that you have children or own another property, perhaps there's no mortgage on it.  Omitting information or not being upfront with your mortgage originator can completely stall, if not derail, your transaction.  Lenders care if you have children especially if the situation involves a separation or divorce.  It's possible that you owe child support and even if you've agreed with your ex not to pay it, what ever is of record (filed with the courts) will most likely be used.  If you have a property that you forgot to add, even if it's "free and clear" of any mortgages, we have to factor property taxes, insurance and other costs into the debt to income ratios.  Pretty much everything on the loan application is verified by the lender.

Form 4506.  It used to be that a 4506 was only ordered on self-employed borrowers, stated income or other "low doc" loans... now every transaction has a 4506 pulled.  A 4506 is a summary of your filed tax returns and it discloses income and deductions that you report to the IRS.  Even if you have a nice salary, if you claim a significant amount of business expenses, it is now common to factor that into the income on your loan application.   This may cause a few borrowers to become disqualified.  Another issue is when borrowers delay filing tax returns as the 4506 is required.  No tax return, no 4506.

Changing jobs or income structure.  Changing jobs may seem like a no-brainer.  It can be done, but DO check with your mortgage originator before making any moves.  Some people may be surprised to learn that changing HOW you are paid may cause some grief with the loan approval process.  And it's not uncommon in this economic climate to have an employer want to restructure your income by reducing the base income and increasing income opportunity by offering more bonus or commission incentive.  It's quite possible, depending on how you've been paid in the last two years, that your lender may be limited to relying solely on your new lower base income. 

Large deposits.  When you provide your bank statements and other asset accounts, all large deposits must be accounted for and documented.  Sometimes your statements may go back a couple months so if you are in the market to buy or refinance your home, keep your checking stubs if your deposits are over $500 (may vary depending on your scenario and the lender).   Be prepared to explain and document your deposits.  If your bank statement shows where the deposit comes from (such as your payroll or an IRS tax refund) you should be fine...it's when your statement just shows an undefined deposit that the additional paperwork will be required.  If a deposit is a gift, that may need to be documented as well...especially if it's being used as your down payment.

Purchases before closing or any changes to your credit profile.  Many lenders are doing "soft pulls" on borrowers to recheck their credit just prior to funding (closing).  If new debts are discovered, the loan will be sent back to be re-underwritten with the new debt.   If the credit report is set to expire prior to closing, that new debt may have dropped the credit score and could not only impact the pricing of the borrowers rate, it could also disqualify borderline borrowers from qualifying.  It just takes having a credit card being used over a certain percentage of the available credit for a persons score to be negatively impacted.   Borrowers should also be careful to NOT close any credit accounts or pay off collections without consulting their mortgage originator.  Closing a credit account with good history may drop your score (scoring modules love old good history vs. new accounts regardless of interest rate or what is better for your financial picture).  Also, paying off a collection prior to closing causes a "new activity" on that collection which may also drop your credit score into lows you'll want to avoid.

Bottom line, be very upfront with your mortgage originator...including letting them know if you have any vacation or time off planned prior to your loan closing.   It's very important to deal with any potential issues possible prior to your transaction instead of potentially risking your time and money should your transaction get delayed or derailed.

Photo credit of the Seattle Monorail:  Brian Teutsch via Flickr

Determining Net Rental Income when Qualifying for a Mortgage

Rental income is generally not fully credited when qualifying for a mortgage.  Lenders will "discount" the rent because of the cost and risk associated with owning investment property.  If someone does not have at least two years history as a landlord, they may not be able to use the rental income at all and may have to qualify with the full mortgage payment.

Conventional financing allows a qualified investor to receive credit for 75% of the gross rental income.  From this figure, property taxes, insurance, home owners association dues and any mortgage payments are deducted to create the amount of rent (positive or negative) that the lender will use for qualifying purposes. 

For example, a property has a $2,000 total mortgage payment (PITI) with no HOA dues and receives rental income of $2,000 per month. 

$2,000 rental income x 0.75% = $1,500.  $1,500 less the mortgage payment of $2,000 creates a net rental income of negative $500 per month.   This would be factored as a debt and not a credit or "breaking even" on the loan application for qualifying.

Of course if there are multiple investors involved, the net rental income is split accordingly.

FHA does not have the same two year history requirement for existing rentals as conventional loans do.  The vacancy factor in the Seattle area is 15% which means that 85% of the rent is allowed to be factored as income.  FHA loans may use future rental income (no 2 year history) when converting an existing home into a rental if the borrower is being relocated or if there is enough equity in the subject property.

To document rental income, be prepared to provide tax returns and signed lease agreements.  When you have rental properties, be prepared to have additional reserves (savings) required based on how many properties are owned.

If you have questions about qualifying for a mortgage for a home located in Washington State, please contact me.  If you would like a personal rate quote from me for an home located in Washington state, click here.