As mortgage guidelines have tightened over the last several years, income verification in particular has become more difficult. The rules of mortgage approval, effectively set by the quasi-government agencies Fannie Mae, Freddie Mac and FHA, are quite particular when it comes to what income can and cannot be considered as a part of your mortgage application.
If you are an average W2 employee with a base salary, the income calculation procedures are logical. You take your base yearly salary and determine the monthly gross – simple, right? However, if your income fits into any of the following categories, the rules could make your head spin:
For each of these categories, there could be a big difference between what you make in reality and what we can consider for your loan application. Without going into detail about each category, I’d like to point out a few common areas where the way the industry calculates your income could dramatically affect your loan options. Guidelines can vary between loan programs, so keep in mind that the details of your exact situation matter in a big way.
If you work in the service industry it is quite common to receive some or most of your income in tips. The problem with this for loan purposes is that often large chunks of your actual income are unreported to the IRS. Also, mortgage approval guidelines are geared toward stability. This is why in order to count even fully IRS reported tips, we must show at least 1 year of job history at the same employer. One other issue with tips and service industry work is that often the number of hours worked per week can fluctuate. For this reason, your gross year-to-date earnings are going to be used to come up with your monthly gross income for the purpose of your loan application.
As stability is a major concern built into mortgage approval guidelines, people that work multiple jobs must show that they have consistently worked more than one job for at least two years. You also need to show that the individual jobs themselves are consistent. This means that if you work 20 hours a week at the library and 20 hours a week at the pet store, in order to count both incomes we need to show a history of holding both of those jobs at the same time for the past two years. If you worked at the library for 3 years, but the pet store only 1 year, this could cause the underwriter not to be able to consider the pet store income.
I could write more on this subject than any other, but I’ll just point out the highlights. The primary challenge I run into with self-employed clients is that their tax strategy shows very little income after all deductions are accounted for. Some businesses, especially new ones, show significant losses. In order for business income to count, it must be relatively stable…not to mention positive. We are also limited to going off of what is actually reported to the IRS. In the case of a new business, it may take years for it to show income that can be used for qualification purposes. For older, more established businesses, owners must consider the impact of their tax strategy on their ability to qualify for financing.
In general, your self-employed income will be calculated based on the average of your previous 2 years of tax returns. However, if the most recent year shows less income than the year before, we will have to use the lower number only. Remember here that the rules, unfortunately, are not designed to be fair! They are designed to protect against risk, which has definitely affected self-employed people in a big way. More than in any other category we’re talking about today, before you assume you’ll be approved for a mortgage, contact your loan officer to make double sure.
Much like business income, the challenge for landlords comes down to the tax return. Tax strategy again can conflict with your ability to qualify for new mortgage loans. One area that can cause frustration is with large repairs. If your most recent year of tax returns shows a big cost for repairs, this could impact your overall income negatively. Even if you have a primary W2 job, rental property losses are counted AGAINST this income to qualifying purposes. Also, do not assume that your leases will be used in the income calculation – tax returns will be the primary basis for this.
More than any other category, the devil is in the details here. If you have started a new W2 position, in most cases we can consider your base income for qualifying purposes like normal. Bonus income for a new job will almost never be used, however. Things get much trickier if this new position doesn’t begin until after closing. This is common for relocating executives, physicians, etc. In this case, you can only be approved for a loan based on the new income if:
-You have a fully executed employment contract. An offer letter is typically not workable without additional documentation from your new employer. The contract must explicitly state your base compensation. Projected bonus income will not be considered.
-You start the new job BEFORE your first payment is due. In most cases, you must also receive a paystub before the first payment comes due. For example, if you close at the end of May, your first payment will come due on July 1. If you do not receive a pay stub before July 1, you will likely NOT be approved for the loan. In this case, you would want to re-schedule your closing accordingly.
Do not assume anything – you will want to talk with your loan officer about all aspects of the new position as part of your formal loan application.
Keep in mind that the ‘bad’ loan programs you’ve heard about – like stated-income and no income verification loans – were originally designed for people that fit into the income categories described above. The reality of what you make can be very different than what we use for your approval. Before making assumptions about what you can qualify for, talk to your trusted loan officer…and be prepared to provide documentation as needed.
I have some clients now who are on the fence. They don’t know if they should buy or rent. Initially they wanted to rent but were having some trouble finding what they wanted. They have a dog and want a yard but can’t find an acceptable rental that allows pets. They are looking for a larger space, preferably a single family home with at least 1.5 baths. And they want it to be nice. Apartment grade finishes just aren’t doing it for them. They are absolutely qualified to buy but just don’t know how long they will be in St. Louis which is why renting seemed more appealing at first. They will definitely be here two years and possibly five but not longer than ten. And that’s why this is a tough choice. They could buy something right now that meets their needs and suits their style for less than would spend on monthly rent. With a purchase there is down payment required and closing cost to pay when they sell. But with a rental it is possible they may have to move every year for as long as they remain in St. Louis. In the end it is really difficult to figure out which is the most economical choice.
Here is an example of their options. One to rent. Another to buy.
Here are some shots of a “private alley house”for rent on CraigsList. It is a 2 bedroom 1.5 bath home listed for $1495/month.
2927 Henrietta is home that is currently listed for $139,900. With just 3.5% down, they could move in and pay less than $1000/month.
Below is a Guest Post from James Kelley regarding Govenrment Backed Loans
Although requirements for conventional home loans and even government-backed mortgage
plans have become stricter, three programs continue to remain buyers’ favorites and offer a
multitude of incomparable benefits: FHA, USDA and VA loans. With decent credit scores and debt to income ratios, the unique opportunities provided through these three programs increase. However, they are also known for being prime home loan programs that help low income families achieve their dreams of homeownership. What do they offer and how
can they help?
FHA and USDA Loans
For USDA loans, the U.S. Department of Agriculture secures them. So, only homes within rural localities can be bought with this mortgage program. Different from the FHA, it does not require a down payment. The FHA loan asks for a 3.5% to 5% down payment on a home, and conventional loans can be up to 20% and more. Other perks include 100% financing, no monthly mortgage insurance fees, and the actual mortgage payment is sometimes lower than the FHA loan. There are household income limits for the USDA loan.
The Federal Housing Administration insures the FHA loan. Unlike the VA and USDA loan, the FHA has no location or vocation requirements. It’s open to everyone.An FHA loan has lower closing costs and no income limits, which is ideal for lower to middle income families. Another great feature of all three programs alike is the buyer can use gifted or borrowed money towards payment of the home. Times are hard, and sometimes people need to go to relatives or friends for a little financial help. Conventional loan programs will not allow such assistance.
The VA loan program is a unique plan for service members. Not many U.S. Veterans utilize or even know about the Department of Veteran Affairs offer to back a home loan for them. In a few short years, the loan has gained increased popularity among lenders.
• A stress-free process
• 100% financing
• Less strict credit and income standards than conventional loans
• No prepayment penalties or private mortgage insurance payments
• A buyer can receive a loan up to $417,000
It’s been a good year for veterans. An extension on the tax credit, plus the U.S. Department
of Housing and Urban Development’s efforts to provide affordable housing to eligible military
members makes now a great time to buy a home.
How to obtain a VA Loan
• A veteran must be able to show that he or she was honorably discharged, or served at
least 90 days on active duty during war or 181 days on active duty during a time of peace.
• One may also be determined eligible if one is a spouse of veteran who is missing in
action, a prisoner of war or died from service related events.
• Find a VA Lender.
• Fill out a Certificate of Eligibility form.
• Find a certified <a href=”http://www.stlouishomeappraiser.com/”>home appraiser</a>.
• In most counties, the VA only secures half of the loan.
• They are not open to everyone. You have to be a veteran.
• In most cases, there will be a small funding charge.
All three programs can help one’s family to potentially obtain their dream home. However, pay
close attention and research which program will save the most money. A lending counselor can
help families to discover their options.
This post was written by a guest blogger Mark Anderson who is a loan office with Pulaski Bank. He specializes in helping first time home buyers through what can often be a very confusing process. He considers himself more of a consultant than a salesperson. He takes client education seriously and his level of customer service is unmatched. If you have any questions about this post or home financing in general please check out his business website.
Effective January 1, 2010, Congress instituted new rules regarding the Good Faith Estimate. Geared toward shutting down predatory lending practices, the rules make it nearly impossible for a mortgage company to quote one set of fees at application and deliver something different at closing.
While the aim is good, the law of unintended consequences has already come into play. Shopping for the best mortgage will now be more difficult and more complicated.
I have often complained about the old Good Faith Estimate and I agree that a change was important. The form had to meet some basic standards, but overall, comparing apples to apples was not easy if you didn’t know what to look for. The old Good Faith Estimate itemized all of the fees associated with a loan closing, including third party charges ultimately not determined by the lender. Lenders could make their bottom line appear artificially attractive by estimating third party fees low. Also, lenders used a variety of confusing, sometimes downright deceptive terms to hide the true cost of their own services. For example, while ‘Tax Service Fee’ sounds like a government imposed charge, it could be $50, $500 or really any number the lender felt like imposing. Maybe some of the fee actually was paid to request tax return transcripts, but I routinely saw my competitors charging outlandish amounts which clearly were not legitimate third party costs.
For this reason, I encouraged my clients to isolate the lender fees and compare those against other quotes, without regard to the varying estimates for third party charges. If the loan officer refused to itemize the actual lender fees, I advised people to walk away.
The new Good Faith Estimate is great in that the true lender cost is reflected very clearly and separated from third party fees. It is now referred to as the ‘cost of origination’. While I am happy with this change, there is a fundamental flaw to the new GFE: lenders are not going to issue them until you select them as your lender. This is because the lender now has a legal responsibility to be so precise that it is simply impractical to issue the form before you file a full application and have a property officially under contract.
The good news here is that once you have selected a lender, made your application and gone under contract, you will receive a Good Faith Estimate that will be amazingly close to the final number at closing. However, since it is impractical for the lender to issue a GFE ahead of time, how can you really shop for the best deal before making a commitment?
Unfortunately lenders will now provide informal quotes that don’t have to meet any government standards. At least the old Good Faith Estimate looked fairly similar from lender to lender. Now, borrowers are going to be faced with such a variety of quote sheets that it will be that much more difficult to compare them.
Despite the problems the new GFE causes with initial disclosure from your lender, you can still exercise control over the quote process in much the same way I recommended before January 1. While the quotes will look different and while they might not be a very good reflection on the actual costs, you can still demand that your lender tell you what they charge.
My main concern with this whole new process is that there was at least some regulation of the old Good Faith Estimate. Now, as a consumer, you will simply have to exert your knowledge as power and show your lender you are aware of the recent changes. Let them know you are also aware that you will always have the ability to move to another lender if their non-regulated initial quote looks much more attractive than the formal GFE.
Good news for homebuyers who weren’t able to make the November 30th cutoff date! Copied below is a note I received from a local lender. His contact info is included if you have any further financing questions
RISMEDIA, November 6, 2009—After the Senate gave final approval last night without a dissenting vote, the House of Representatives voted overwhelmingly this afternoon to pass legislation containing an extension and expansion of the homebuyer tax credit, completing Congressional action and sending the tax credit to President Obama for his signature, possibly as early as tomorrow.
The $8,000 homebuyer tax credit for first-time buyers, due to expire in 25 days, will be extended through April 30 of next year and buyers will have an additional two months, until the end of June, to close. First-time buyers who are in the process of making a purchase will no longer need to worry about qualifying for the $8,000 credit if they close after the November 30 deadline. The new legislation increases the income limit for couples with income up to $225,000, a nearly $55,000 increase above the level in existing law.
For the first time, the new legislation makes buyers who already own a home eligible for a credit. A $6,500 maximum credit will be available to existing homeowners who have lived in their current residence for five of the prior eight years. The legislation limits eligibility for the existing homeowner credit to homes worth $800,000 or less.
The legislation takes effect December 1 and is not retroactive. Both credits are available only for primary residences, not second homes or investment properties.
Glenn Hayhurst, President
Strategic Lending, Inc.
toll free: 866-577-0866
Thanks to Mark Anderson from Pulaski Bank for writing this post! Mark has been a great resource for me and my clients. If you have any further questions about this post or other financing options, please contact him directly. All his info is on his site.
The Missouri Housing and Development Commission, or MHDC, has an excellent new program for buyers purchasing foreclosed homes. First-time and repeat buyers will receive funds up to 20% of the foreclosed property’s sales price, with a maximum of $14,999. This amount can be applied to the purchaser’s down payment and closing costs. The money does come in the form of a 2nd mortgage (as opposed to being a grant), but the loan has 0% interest and is forgiven after 5 years of occupancy.
In order for buyers to qualify, the following conditions must be met:
In St. Louis City and County the total household income must fall at or below limits based on household size. For one person, the limit is $57,000. A family of two can earn up to $65,150 and still qualify. From there, you can add about $8,000 to this limit for each additional member of the household.
The buyer’s first mortgage must be an MHDC First Place Loan, which is an FHA 30-Year Fixed product at 6.0%. The interest rate is currently above normal FHA loans by about .5%, but the higher rate is almost undoubtedly worth it given the cash incentive.
The buyer must go through approved homebuyer education.
The purchase price for the foreclosed property must be discounted by at least 5% from the appraised value.
The buyer must live in the property as their primary residence.
If the foreclosed property was rented, it must have been clear of tenants for at least 12 months.
The best thing about this program is that first-time buyers can still take advantage of the $8,000 federal tax credit, for a total maximum benefit of over $22,000 for purchasing a foreclosed property. One thing to keep in mind is that MHDC has a limited pool of resources to fund this benefit – as compelling as it is, I suggest moving quickly!
Many of you have probably heard something about the tax credits for first time home buyers as part of The American Recovery and Reinvestment Act of 2009. This site does an excellent job explaining the details of this and who is eligible.
One point of clarification before you read on: while this is indeed a great incentive, it is not a check you get once you close on the house. I’ve seen and heard ads from some agents enticing potential clients with some borderline misleading tactics regarding this.
This is something worth looking into if you’re on the fence about buying, and definitely something you need to look into if you did in fact buy your first home in 2009. Don’t let the negative news coverage discourage your efforts to own a home. I really do believe it is still the Golden Age for First Time Buyers!
St. Louis is considered to be in the West North Central region along with Iowa, Kansas, Minnesota, Nebraska, North Dakota and South Dakota. Two figures are given for MO: St. Louis and Kansas City. The numbers below come from the St. Louis section.
Attic to Bedroom
Job Cost: $54,112
Value at Sale: $38,568
Cost Recouped: 71.3%
Midrange Kitchen Remodel
Job Cost: $22,128
Value at Sale: $16,463
Cost Recouped: 74.3%
Upscale Bathroom Remodel
Job Cost: $55,035
Value at Sale: $38,707
Cost Recouped: 70.3%
Where to get the most bang for the bucks?
Average return on a wood deck in our region: 76.1%
Average return on fiber cement siding: 79.9%
Mark Anderson is a lender with Pulaski Bank that I work with quite often. Lately I have heard a lot of concern from some of my clients who are just at the beginning stages of looking for a home. The general concern is that they won’t be able to qualify for a loan or they will be required to have a huge down payment. Below is Mark’s response to that concern.
Despite what we’re hearing on the news, very little has changed with access to financing for average home buyers. It is true that the credit markets have tightened. It’s also true that some banks have gone out of business. But these changes have had very little impact on basic approval standards for home loans. Chances are, if you have at least fair credit and are able to afford the house payment you are looking to take on, you can be approved for a mortgage. And again, despite what you may hear on the news, you won’t have to take a high interest rate, or an adjustable loan just because you don’t have a 700 credit score.
The one major change that has affected home buyers over the past 12 months involves down payment requirements. You used to be able to take a 30-year conventional mortgage and not have to make a down payment at all – as long as you met certain approval standards. These days, you will have to make a down payment, but the amount is not as much as you may have heard. No one waived a wand and required all borrowers to make 20% down payments, regardless of the credit crunch. In fact, the minimum down payment available, through FHA, is 3%. What’s even better is that this 3% can come from gift sources or from the State of Missouri first time home buyer program, MHDC. Using either a gift from family, or funds from MHDC, you can actually still purchase a property with minimal out of pocket cost.
Dawn and I recently closed with a client who took advantage of MHDC. After negotiating for the seller to pay closing costs, our client only had to come up with enough funds to cover her home inspections and a couple other optional add-ons like a home warranty plan.
To take advantage of MHDC, you need to have not had an ownership interest in a Missouri property for the last 3 years. Your income also needs to be under a certain level depending on how many people are in your household and in what area you are intending to buy. MHDC is called a ‘no interest, forgivable second mortgage’, meaning that you don’t make payments on the money and that over time, the loan balance diminishes. Every year you remain in the property after the purchase date, one-fifth of the balance is ‘forgiven’. After 5 years, the balance goes away entirely.
MHDC goes through periods of availability. Right now there are still funds available. Once they are gone, you can be added to a waiting list. Feel free to contact me anytime for up to the minute details on availability and on qualifying guidelines.”
First a little history: FHA stands for Federal Housing Administration, an entity created by the The Housing Act of 1934 which was desinged to increase homeownership by operating different loan insurance programs. So when someone says you have an FHA loan, it doesn’t mean the Federal Housing Administration gave you the money, it means that the FHA is insuring the principal amount that your chosen bank lent you.
With an FHA a buyer can finance up to 97% of the sale price meaning a potential buyer will only need a 3% down payment. The borrower must meet standard FHA credit qualifications. Additionally the home being purchased must also pass an FHA appraisal and meet the other FHA guidelines.
Now that the 80/20 and other creative financing options are off the table I have seen a rise in the number of borrowers utilizing an FHA insured loan. Out of 8 contracts I have that are scheduled to close between September and October, 5 of the borrowers involved are using an FHA loan.
If you are using an FHA loan these days, it is important to choose a home that will pass an FHA appraisal. In this market that can be kind of tricky. There are so many foreclosures, short sales and handyman specials to sift through. Obviously everyone is looking for a good deal and foreclosures can be a good options, but they won’t all pass an FHA appraisal. If you are using an FHA loan there are may hurdles you can run into in terms of the home meeting the guidelines. Does it need significant repairs? If so, can the current owner of the property have them repaired prior to close? If it is a condo, is there enough money in reserves to meet the FHA guidelines? If it is condo, are enough of the unit owners, owner-occupants?
I am not suggesting that you avoid Bank Owned properties and condos altogether. But I do think it is important that you do a good amount of investigation prior to making an offer. By working with your lender and Realtor you should be able to get a good idea before you ever write an offer if the house will conform to the FHA guidelines.
It is very possible to find a foreclosure that will pass an FHA appraisal. But the risk is having something called out on the appraisal and then not being able to have it repaired prior to close. Most banks state in the MLS listing that NO REPAIRS will be done to the property.
If, however, the home is owned by an individual that is willing to address any FHA predications, even if it needs a new roof or electrical panel, you are much more likely to have a smooth transaction.
I think FHA loans are good products and I believe that the contingencies built in are really in the best interest of the buyer, but I think it is important that you do your due diligence prior to writing a contract so that you don’t find yourself out $800 (inspections) and in love with a house that simply will not fit your financing package.
Dawn Griffin Real Estate Blog
I’m an experienced Saint Louis Realtor specializing in St. Louis City as well as neighborhoods like Webster Groves, Maplewood, Clayton, University City and Ladue. With an undergraduate degree in Education and Master's in Urban Planning and Real Estate Development — I have the heart of teacher.
I have been immersed in Residential Real Estate, helping home buyers and sellers understand the market, manage the ambiguities and negotiate the best terms for themselves. I am consistently voted a 5-Star Agent by clients and featured as one of St. Louis' Best Agents in Saint Louis Magazine.