Beware of Bonus Income Guidelines
To qualify for a conventional mortgage, your income should be “…stable, predictable and likely to continue”. You need to demonstrate your ability to repay – and, ideally, that your income is likely to continue for 3 years. If you earn bonus or commission income, your employer needs to verify that you have received it for the past 12 to 24 months – showing positive factors that offset the shorter income history.
But what if you decide to move to a different location (i.e., to maximize your earnings, to be closer to family, or because it’s just too cold where you are)? Unless your “transfer” is with the same company, you won’t be able to use your bonus income to qualify for a mortgage in your new location.
One of my clients has had consistent earnings with the same major automotive company for 25 years. But because the dealerships are franchisees, each franchisee is deemed to be a separate employer – so his move from one franchisee to another disqualified him from using his bonus income. And because the majority of his income is always from bonuses, he couldn’t qualify for a conventional mortgage. Even though he generated consistent monthly bonuses over the past 7 months at the new franchisee, he needed to show at least 12 months of bonus earnings.
The Federal National Mortgage Association (FNMA) would not bend the rules for this solid income earner. The prevailing private lender agreed that the conventional bonus income guidelines do not incorporate common sense.
Here’s the Point: If you do not have at least 12 months of bonus or commission earnings, you will not be able to use that income in your mortgage qualifying ratios.
Condo Loan Craziness
Just because you have good credit, low debt-to-income ratios and a good size down payment, don’t think that qualifying for a purchase mortgage on a condominium will be a breeze. It may not be you that the Federal National Mortgage Association (FNMA) is concerned about. Since FNMA is the likely buyer of the mortgage advanced by your lender, they are fastidious about how the condo homeowners association (HOA) or property management company is managing the affairs of the building.
There are some rules you should know before making an offer:
- If you intend the condo to be an investment property, over 50% of the units in the building must be owner-occupied.
WHY? Owner Occupants look after their units and are less apt to default on their mortgages - If the building offers in-room housekeeping and concierge services, FNMA will assume the condo is operated as a hotel and your loan will be declined.
WHY? Short-term rentals (daily/weekly/monthly) are prohibited – whether offered by the HOA or the unit owners (and if the latter, the HOA will need to police this use)
It is not easy for the HOA to monitor the number of rental units – in which case the appraiser will need to make what is often an unreliable estimate. If this estimate is high, it triggers a red flag in the eyes of the lender. Letters of explanation and verbal confirmations will be required, thereby causing substantial delays and increasing the odds that your loan may not close.
Here’s the Point: Need a loan to buy a condo unit? If the building offers short-term rentals, chances are you won’t get your loan.
Free Money at the Closing Table
Free? I think not! But there are definitely “lender credits” available to you, depending on the interest rate you select. The technical term for this credit is “yield spread premium”. But is the 
lender passing this credit on to you, or are they keeping it – and therefore booking additional profit from your loan? This profit would be in addition to their processing fee, and results from the earnings spread they generate between what you pay them versus what it costs them to fund your loan.
The higher the interest rate you pay, the higher the credit to which you should be entitled – all of which can be applied towards offsetting your closing costs. In arriving at this credit, the lender factors in certain standard risk adjustments that are based on variables such as your credit score, loan amount, collateral type, and loan-to-value ratio. The lesson to be learned is that your lender should always fully disclose the amount of this credit – even if it is in the form of a reduced interest rate.
Recently I had a client who was able to increase his lender credit by simply taking a few steps to improve his credit score. After following a program of credit card debt reduction, his FICO score increased from 599 to 642. This favorably resulted in an increase to his lender credit of 1.25% of his loan amount – a savings of $2,500 which he was able to apply towards the closing costs on his $200,000 residential mortgage.
Here’s the Point: The next time you get an interest rate quote from a lender, be sure to ask them how you can increase the “credit” to which you may be entitled to apply against your closing costs.
Identity Theft: Curious Advice…
Imagine some guy by the name of “Greg” using your name and social security number to borrow three private loans totaling $10,000. Wouldn’t you feel violated? You would also be furious if this showed up on your credit report only 5 days before your new mortgage is scheduled to close!
The fraudster is not about to make principal and interest payments on the scam loans. So your credit score will immediately deteriorate because of late payments, which you likely won’t even know about – unless you frequently check your credit scores.
This happened to a client of mine last week. His attorney recommended that he: (i) request a fraud alert be placed on his credit report, and (ii) commence making the required monthly payments on the fraudulent loans…
PARDON??!
Imagine making payments on a fraudulent loan – and then trying to prove later that your payments should be recouped? I don’t actually blame the lawyer – because he was simply trying to stop the fraudster, and help the borrower get a mortgage by maintaining a decent credit score. What was missing, however, was that a new conventional or FHA mortgage lender will require evidence that an act of fraud had been committed – which will include the filing of a police report. The omission of or delay in filing this report gives the appearance of “hiding” the identity theft. It is very important to demonstrate to the lender that all the right steps have been taken to address the problem as quickly as possible.
Here’s the Point: You can’t hide identity theft when you apply for a mortgage. Promptly have the credit bureaus put a fraud alert on your credit report so that no further borrowing can take place without your approval.
Refinancing? The Grass Isn’t Always Greener
My client made the right decision last week. He decided not to refinance his mortgage – even though:
(i) he qualified for a better interest rate (because his credit score had improved),
(ii) the value of his primary residence was way up, and
(iii) he could have used some of the equity in his home to consolidate debt.
His credit score was 650 – lower than what he had hoped for, mainly because of some unavoidable late payments a while back. Keeping his loan-to-value ratio at 80% (to avoid mortgage insurance premiums), he was surprised to discover that, with his credit score, he would still be assessed 3.0% of the loan amount at closing. In addition, because he was looking to pull out some equity (i.e., obtain a new loan greater than his existing loan amount), the “cash-out refinance adjustment” would have been another 2.625%. Along with a couple of other incidental adjustments for loan size and overall risk profile, the cumulative risk adjustments would have been 5.85% of his requested loan amount – or $5,850 on a $100,000 loan.
Sure – I found a lender who would offset all of these costs. The problem was his interest rate would be no different than the rate he already had on his existing loan. Also, his principal amortization schedule would reset upon the commencement of his new 30-year mortgage. Therefore, the portion of his new monthly mortgage payment attributed to principal reduction would be less than what his principal payment was under his existing loan.
Here’s the Point: Make sure to understand all of the “risk adjustments” (costs) that lenders assess before you refinance your mortgage – because you might be surprised.
Christmas Without a Mortgage
My lender declined my client’s mortgage today, four days before Christmas. His existing loan expires on December 31, and this was his last chance to refinance before the lender could commence foreclosure proceedings.
This 70-year old gentleman has no late payments on his credit report. However, a credit card company entered a judgment against him six years ago, and conventional lenders require this to be removed before extending new credit. Unfortunately, he lacks the liquidity to eliminate the judgment, and his age has been an obstacle to finding a job to augment his social security income. Although the private lender liked his story, they would not accept a Debt-To-Income (DTI) ratio over 50%.
Many people rent the other side of their duplex – but the key issue is whether the lender will classify the rent as “boarder” income (100% of which may be used for qualification purposes) or “investment” income (only 75% of which is allowable – to factor in the potential loss of the tenant). The boarder income argument was valid because the building has only one tax parcel number and is still technically his primary residence. But the Underwriter disagreed, and the resulting lower income caused his DTI ratio to exceed the maximum threshold.
In the end, the proposed structure was declined at a lousy time of year. Fortunately, the lender agreed to approve a lower loan amount – and at a better interest rate. My client also has the ability to raise rent, which the tenant knows is below market.
Here’s the Point: A loan may be declined as presented, but it should be incumbent on every lender to offer at least one alternative structure which would allow the loan to work.
Excuse Me? Who are the “Entitled” Ones?
There are lots of articles written about Millennials – you’ve read them (e.g., the notion that they are lazy, filled with too much self-regard, have unrealistic monetary expectations, etc.). The ages of Millennials varies depending on the author, but seems to focus on the era between 1982 and 2004 – or, said another way, their average age today is about 22.
What does this have to do with mortgages you ask?!
For all the perceived negatives, these “kids” (I can call them that because they are younger than my children) are the most adaptable and cooperative of all my clients. EVERYONE (note the emphasis) must open their books to get a mortgage done today – regardless of age or socioeconomic status. This is mainly thanks to the Consumer Finance Protection Bureau (CFPB), which significantly tightened the regulations for mortgage qualification purposes after the 2007 U.S. Housing Crisis. Sure, I complain about the paperwork all the time, but welcome to the new reality – which, by the way, is here to stay.
For the most part, I don’t have a problem with the requirements – and I deal with them every day. Consumers get more sensible mortgages and banks have stronger balance sheets to return dividends. From my experience, the people who have the biggest problem with regulations are the affluent Baby Boomers (1946-1964). Is it because many of them have never had a mortgage? Regardless, they have the perceived notion that: The higher the net worth, the less paperwork that should be required. Wrong.
Here’s the Point: No one is “entitled” when it comes to providing paperwork for obtaining a mortgage – and that is exactly the way it should work in the marketplace.
Rent: Still Paying Cash?
If you need a mortgage, but you do not have established credit – i.e., at least two active credit cards or a car loan/lease, then all you can do is demonstrate that you are honoring your rent obligations. Sign a lease, pay rent via check each month, and retain your bank statements and cancelled rent checks for at least 12 months. Without these items, you better have a good relationship with your landlord – because you’ll need a letter confirming you consistently pay rent on time.
Here are some statements which will fall on deaf ears at the bank:
“I’m sharing an apartment with a friend and I pay him cash for my share. He then sends the full amount of rent by check to the landlord on time every month.”
⇒That’s nice, but you need to show consistent cash withdrawals from your bank account every month in the exact amount of your share.
“I live at my daughter’s place and I cook, clean, and I timely pay for most utilities every month. And lately I have covered all of the capital improvement and repair costs.”
⇒That’s nice, but you need consistent outflow of your contributions, and to show that the utility receipts match the corresponding withdrawals from your bank account.
“I’m renting from my aunt. She trusts me so there has been little point in drawing up a lease contract.”
⇒That’s nice, but without a contract you can neither demonstrate that you have any obligations nor lived up to them!
Here’s the Point: To obtain a mortgage without established credit lines, the lender will require at least 12 months of cancelled rent checks and/or a landlord “Verification of Rent” letter.
Really Bob? Are You Sure About That?!
I’m buying another property, but I plan to call it a second home so that I can get a better interest rate.
No You’re Not: Unless it has vacation/resort amenities and is 50+ miles away from your primary residence, it will be treated as an investment property and carry a higher interest rate].
- WHY? Because it’s not your vacation home
No Sir: You can only have one FHA loan at a time and it must be on your primary residence (and besides, there are conventional financing programs that offer loans as high as 97% of value).
- WHY? Because FHA financing is meant to help consumers purchase their home
Not True: Depending on your ability-to-repay, Freddie Mac may only require one year of tax returns from your new business.
- WHY? Because Freddie takes compensating factors into consideration
Incorrect Again: A parent/child profit-sharing relationship is deemed an “identity of interest” transaction, and the buyer is restricted to 75% loan-to-value when there is a non-occupying co-borrower.
- WHY? Because the borrower should solely benefit from primary home ownership
Here’s the Point: The number of rules imposed by Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) can be daunting – but most of the time they actually make sense.
ARM’s Had A Bad Rap
Unlike “Fixed Rate Mortgages”, having an interest rate that remains the same for the entire loan term, rates on Adjustable Rate Mortgages (ARM’s) change periodically. You would think in a rising interest rate environment that locking your interest rate would make the most sense – to avoid higher monthly mortgage payments. Then why are ARM’s making a comeback?
To start, ARM’s have lower interest rates than 30-year fixed rate mortgages (so the monthly payment is lower, allowing borrowers to maximize their cash flow). ARM’s therefore offer more payment flexibility (not only can borrowers use the resulting savings towards personal expenses, but they can elect to make additional principal payments on their mortgage).
Plus, people generally do not stay in the same home for more than about 7 years. If you enter into a “7/1” ARM, this means that the interest rate is fixed for 7 years, and then the rate adjusts thereafter based upon prevailing rates at that time. Sound risky?
In the past, ARM’s were much riskier loans. Depending on the lender, ARM’s may have had:
- prepayment penalties
- more frequent rate adjustment periods
- less or no principal amortization
- high or no ceilings on the amount the rate could increase upon adjustment
All of these onerous terms changed with the onslaught of regulations after the housing crisis. Today, ARM’s “cap” the amount of rate increase at the time of the required adjustment – and the interest rate is prevented from increasing by more than 5% over the life of the loan.
Here’s the Point: For savvy, budget-conscious borrowers not likely to retain their real estate asset long term, it would be worthwhile to explore the pros and cons of an ARM.
