One of the basic theories in Physics is “for every action there is an equal and opposite reaction.” In many ways the same holds true in mortgage financing.
When a potential borrower submits a loan application, supporting documents are required in order to verify its accuracy. In addition detailed explanations maybe needed to justify certain events than have occurred to clarify gray areas. Typically, borrowers are given a basic list of initial information needed to start the process. However there are always questions that will arise in each transaction. While there are so many factors to be aware of, here are the some of the most overlooked or misunderstood elements that will certainly prolong the process and at times could kill the transaction.
Let’s start with Funds to Close and Unusual Deposits- The source of your closing funds must be verified from the account(s) you’ve listed on your loan application. There are times when a borrower has provided the proper trail yet at the last second accesses an account other than the one designated. This will always cause delays. If your funds are coming in the form of a gift from a relative you must show the proper clear cut audit trail of funds being transferred to your checking account or wired directly to title. In addition, proof that the donor had the ability to provide the gift, by way of bank statements, along with a signed gift letter are required. Another red flag are unusual deposits, which are not from normal wages and earnings. These deposit come in many forms. For example, a repayment of a personal loan to a friend that was repaid in cash will be scrutinized and if a proper trail cannot be provided will be excluded as funds you’ll be able to use to close. This could create a shortage to close.
Employment History- A two year history of employment must be verified to calculate the expected future earnings and the probability of its continuance. Any gaps of employment must be explained, such as taking time off before starting a new job. Being employed with a current employer for less than two years, in most cases is acceptable provided the move is within the same line of work. A self-employed borrower who has accepted a salaried position (W-2) with a new company in the same field, will typically be qualified on his contractual income from his employer. However, a salaried employee who decides to become self-employed (1099/ Schedule C income) will be required to wait until there’s a two year history of verifiable income through tax returns.
Bonus/ Commission Income and Second Jobs- If a borrower wishes to qualify using bonus income, which is above and beyond their normal salary, we will need to analyze the previous two years worth of bonus’ and determine if they will continue in the future. The same holds true for commissioned individuals, however, all income will be averaged unlike the salaried individual whose bonuses will be averaged. Once again the magic number of two applies to second jobs. Two years and the expectation of continuance must be verified.
Other Income Sources- There are many forms of other income. The most common are Social Security benefits and retirement benefits. Typically, these types on income are directly deposited into the recipients account. An award or benefit letter from the source along with bank statements showing the deposit into the account are the best ways to verify receipt. If funds are not sent direct deposit, a copy of the most recent check will be required along with verification of benefits, which in all cases must continue for a minimum of three years.
2106 Expenses- 2106 expenses are non-reimbursed work related expenses that the IRS allows certain employees to write off against their income. Most borrowers don’t realize that standard underwriting guidelines requires that this will reduce their income by the amount of expenses that a borrower deducts for his 2106 items; thus, reducing their purchasing power.
Other Real Estate- Not disclosing all properties on a borrower’s tax return (the Schedule E), can cause major delays. Even if a property is free and clear, underwriting will need to document proof for taxes and insurance. Borrowers must qualify with all real estate expenses even if title is not in their name or someone else is making the payment. Purchasing a home and retaining your current property to become a rental comes with its own set of challenges. Unless there’s at least 30% equity in the departing property, the full amount of the payment will be used against the borrower for qualifying purposes, even though it may be rented, which can drastically reduce buying power.
Property Listed – If you’re looking to refinance your home and it had been listed for sale in previous 6 months, unless a logical explanation to proceed isn’t provided, this could delay your ability to finance. This will be discovered in the appraisal process and could cost unnecessary appraisal fees.
Rate-Term vs. Cash-out Refinances- Rate and Term refinance can only pay off mortgages used at time of purchasing the home. During the sub-prime frenzy, a first and second mortgage were closed simultaneously, which in essence acted as one loan. When attempting to pay off a second mortgage, if it’s discovered that it was not used to purchase the home but was instead a line of credit obtained after the fact, this turns the new loan into a cash-out situation. Get proof upfront by showing your HUD-1 closing statement at time of purchase since there are much different loan-to-value and pricing guidelines.
Liabilities- There are times when the actual obligation and the minimum payment to be made are not accurate based on the credit report. Forwarding a recent statement to the credit bureaus to make corrections will solve the problem and a credit supplement will be issued. Be very aware of 401K loans through your employer, which will not show up on a credit report but will always be identified on a pay stub. If the payback is greater than six months, the monthly payment will be treated as an installment loan which once again will reduce purchasing power.
Credit Reporting – Last but certainly not least are some simple tips that should be followed, leading up to the application process with respect to credit. Here are the most critical:
– Limit the amount of credit inquires, which have a negative effect on your credit scores.
– Keep your outstanding balances on each of your revolving accounts below 30% of the available credit.
– Any accounts that are in dispute must be taken out of that status. Disputes will arbitrary increase your scores and don’t provide an accurate rating.
– Never close good revolving accounts despite how little you may use that card.
Understanding some of the underlying questions your lender will need to address and being proactive before starting the process, will make it a far less stressful experience. In some cases, it may make the difference of actually obtain a loan.
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