Sunday, November 7, 2010

How Does One Qualify for a Mortgage These Days?

The Hangover
Let's look at a drinker. Not a raving alcoholic that gets drunk regularly, rather our drinker - we'll call him Jim - will control his consumption most of the time. However every once in a while Jim will let the moment get the best of his judgement, and he'll get smashed. When I was in college we called it FUBAR. Well, Jim had a bad binge and is terribly hung over. He has the kind of headache that makes you think if you could just drill a hole in your forehead, you could relieve the pressure inside. His entire body aches and he wishes he had listened to his girlfriend and gone home early. He swears he will never, NEVER EVER get drunk again. Hopefully he's learned his lesson. Eventually he will loosen up and have a few drinks at a party, but for now he has sworn-off the sauce.
Jim's attitude towards alcohol is not unlike a mortgage lender's toward home loans. The lending binge of the housing boom led to our recession/hangover. There's a party happening in the form of low interest rates. Mortgage lenders are attending the party, but they are very careful not to indulge too much.

A week doesn't go by that I hear a news story about interest rates being at historic levels, "BUT, good luck finding a bank that will lend to you," the reporter says. Mortgage lenders are much more discriminating than they use to be in who and how they lend money for home loans. Qualifying for a home loan is more difficult, but it's not impossible.

There are three areas that a mortgage lender considers when determining whether to approve a home loan application. We call them the Three C's: Capacity, Character, and Collateral. Capacity is the borrower's ability to repay the loan. Character is the borrower's willingness to repay the loan (based on credit history). And Collateral is the asset used to secure the loan, the home.

As a borrower, be prepared to prove your capacity to pay back the loan. Provide recent copies of paystubs, and W-2 forms for the past two years to prove you have enough income to repay the loan as well as your current debt obligations. Self-employed borrowers will need to provide two years of individual and company tax returns.

Another component of Capacity is the amount of borrower's assets. Two months of bank and investment account statements will satisfy the documentation requirement. Be prepared to provide a documentation paper-trail for any unusually large deposits.

Since a mortgage underwriter that makes a lending decision will never get to know or even meet the applicant, they judge the borrower's character by what they see on a credit report. Whether the borrower has defaulted or made late payments in the past will help the underwriter determine the borrower's willingness to repay the loan. Severe delinquent events on the credit report such as a bankruptcy, foreclosure, or short sale tells the lender that the borrower has walked away from obligations in the past. This will keep the borrower from obtaining a new home loan for several years.

The asset that secures a mortgage is the borrower's home. The lender will obtain an appraisal report to make sure the current market value of the property is sufficient to secure a home loan. Many borrowers have had difficulty refinancing because they purchased the home at the peak of the market and now the value of their home is insufficient. But those that had large down payments or bought their homes prior to the run-up in the housing market likely have the equity necessary to refinance.

If a potential borrower can provide the documentation necessary to prove their Capacity, have the credit history that shows good Character, and are purchasing or refinancing a home that is sufficient Collateral, then they can qualify for a home loan. Contrary to some negative news reports, people are doing it every day.

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