I was born and raised in southern California - one of the USA's most expensive spots to live. No matter how hard I worked, I was always behind the housing market. When the average home price for a house you'd want to live in hit $580,000 in 2004, I knew I'd have to leave the state in order to own a home before I died. I'm 51 now, and the prices are still breaking records monthly.
So, like the informed consumer I am, I started my research. I called a mortgage broker to discuss what options were out there for self-employed people. He told me how I could qualify, how my hard-won high credit score (more about that later) would help, and what sort of loans were out there. He warned me off some packages, led me towards others.
He was honest and upfront in warning that as a self-employed person, I'd probably get penalized on what sort of package I could get, but stressed that I could get a loan, and suggested I go to a low-documentation, or "stated income" loan.
Stated Income Mortgages
Bear with me here, this might get a bit technical - it was for me.
Stated Income Mortgages are the most commonly used and least expensive product in the reduced or no documentation suite of programs. A Stated Income Mortgage Loan is often the perfect choice if you have verifiable employment (self-employment is fine and usually two years is the minimum) and assets. Income that is stated on the application must be reasonable in terms of your occupation and assets.
The Stated Income Mortgage is the least expensive reduced documentation product if it works for you. If not, a No Ratio or true No Doc mortgage but may be a better choice.
Stated Income Mortgage Loans are available as:
• 15 or 30 year fixed rate; require only 5% equity and the rate will not change, however rates are lower with more equity.
• 5 year ARM or interest-only options
Stated Income Mortgage Loans are available for single family, townhouse, some manufactured housing, and low-rise condos. Some programs allow high-rise condos, 2-4 unit buildings, second homes or investment properties but are slightly more expensive or require more equity.
Allowable uses are for purchase or rate and term refinance. The programs will allow a "cash out" refinance but there are limitations on the allowable cash back. The fundamental thing to keep in mind with true No Doc Mortgages is that the lender only has your credit profile and property to evaluate. If your situation allows verification of either employment or assets you will save some money because you have lowered the lenders risk. The choice is yours.
What I learned were the general guidelines for a Stated Income Mortgage Loan:
• Minimum middle credit score is 640;
• 5 credit accounts are required. 3 may be from alternative sources -- utility, auto insurance, etc.;
• Bankruptcy and foreclosures must be discharged for 3 years with re-established credit in good standing;
• Two years employment with same employer or in the same business;
• Two months PITI reserves are required with an LTV • 5% minimum down payment is required from your own funds. No gifts.
I started looking when I decided that this was my only option for a mortgage. I knew that the Pick-A-Payment option loan I could handle. I had sold my small home and had $42k in cash and a good credit score.
Unfortunately, what was available within my budget was too far from my client base, and in the long run, gas would cost me more than my mortgage. So I made plans to move to North Carolina, where I had friends, and found I'd get a lot more home for the money.
Finding A Realtor
I had searched Homes.com, and found a couple of interesting houses in the area I thought I wanted to be in, so the Realtor and I started an ongoing conversation. He had excellent lenders (gave me the choice of 3) and I packed my stuff and drove across country -- see On the Road Again for the full sga -- and planted myself in the heart of Cary, NC, in the ExtendedStay America Hotel (I had no idea how extended it would turn out to be).
I looked at the houses I had found online with my Realtor. Just as a side note, some houses photograph REALLY WELL. But like characters on a reality show, the inside doesn't always match the outside. So I let him show me some homes he had, and the second one was it. 4 bedrooms, 3.5 baths, two story, two-car garage, with a bonus room (the old garage), an attic, and new master suite over the new 2-car garage, all for about $200k -- oh yea, and a one-acre corner lot! JACKPOT! This home in California would be in the $1-$1.5 million range. It was my dream home. Too bad I had to drive 3,000 miles to find it.
I made an offer, and it was accepted. Then the real work began.
Working With Your Lender
I chose a lender from the three offered, because he understood how much this meant to me and promised to do whatever it took to get me into this house. He did, though it took more work than I expected. I got frustrated at times, really angry at others and finally realized, closings almost always take at least a month. I had initially been told that we could close in 2 weeks because the house was empty.
I had to show my last year's tax statement, which had a business loss of $5,000, but when I explained that I averaged a certain income each year, that became my "stated" income. Then I had to decide how much to put down, because I didn't want to deplete my reserves and be left with no money to make changes. So I decided to put down half of what cash I had, and take out a second mortgage.
NOTE: When you put down less than 10%, you have to pay for PMI - private mortgage insurance. So, in order to eliminate that, a second, interest-only second mortgage will fulfill the requirement of 20% down.
Underwriting - Why They Call it That
After the information on the loan application has been validated, the value of the property has been confirmed and the title search has been completed, the loan is ready to be underwritten. Usually, a trained professional reviews all of the information, analyzes the creditworthiness of the borrower and renders a decision on the loan request.
Increasingly, much of the analytical portion of underwriting is performed by technology through artificial intelligence and use of databases. There are general secondary market underwriting guidelines, but many variables are considered in the analysis.
These are some of the areas covered in the process:
• Monthly Housing Expenses and Total Debt Obligations One of the first things an underwriter determines is the borrower's proposed monthly housing expenses and total monthly debt obligations.
• Monthly IncomeOne of the most important components of the loan underwriting process is determining the borrower's monthly income. The income of all borrowers and co-borrowers is included in the calculation. The income can be derived from several sources, but it must be supported by historical documentation and have a high likelihood of continuation. The following outlines the types of income that are used and the means to support them:
- Salary Income derived from any kind of salary, whether monthly, weekly or hourly is acceptable. Two year employment history is usually required.
- Commission and bonus Commissions and bonuses can be used for income. The underwriter will average the last two years of income shown on federal income tax returns and the year-to-date earnings from the written verification of employment or pay stubs.
- Self-employment income Generally, the underwriter will average the income derived through self-employment for the last two years from the applicant's federal tax returns and the year-to-date earnings from a profit and loss statement on the business. Usually, underwriters will take into consideration the income trends in the business, as well.
- Other income Other income can be used for loan qualification. Income derived from rental properties, interest, dividends, pensions and social security can be used.
• Income to Debt Ratios After determining the monthly income of the borrower and any co-borrowers, the monthly housing expenses and the total monthly debt obligations, the underwriter calculates two ratios that are helpful in the loan underwriting process: Primary Housing Expense and Total Obligations to Income Ratio. Qualifying ratios are only one component of the underwriting process and many other variables are considered in the final decision.
• Funds to CloseWhen the proposed loan is being used to finance the purchase of a home, underwriters will determine the source of funds for the down payment and closing costs. The following are acceptable sources of funds for closing:
- Cash Cash in any depository institution or investment company is acceptable.
- Stocks, bonds, mutual funds, etc. Cash equivalent investments are acceptable forms of funds. They can be validated through statements from investment companies for the last two months.
- Sale of existing property Many times the source of funds for the down payment on a home comes from the equity in a property that will be sold. The sales price of the property being sold is indicated on the loan application and any existing loan is verified on the credit report or through a verification of previous mortgage.
- Gifts Gifts from family members for the down payment and/or closing costs are acceptable so long as there is no requirement for repayment. Some loan programs limit the amount of gift funds allowed.
• Credit AnalysisAnother part of the underwriting process is determining the creditworthiness of the borrower. Loan underwriters review the borrower's credit report to find evidence of debt repayment behavior. Some of the important areas that are reviewed are:
- Past and existing mortgage debt The past repayment history on mortgage debt can be a good indication of a borrowers attitude toward mortgage obligations. A good payment history on mortgage debt is very important in the credit analysis. Generally, payments received 30 days past the due date are reflected in the credit report as late. Lenders vary in strictness and some may not allow any late mortgage payments, while others will allow 1 or 2 in the last two years if there is a good explanation.
- Installment and revolving credit Other items on the credit report can also indicate a borrower's attitude toward credit obligations. Credit reports indicate the outstanding balance, current balance and terms of payment on the borrower's revolving and installment debt. Underwriters review these credit obligations to determine the borrower's patterns of credit use and repayment behavior. Generally, underwriters are not concerned over isolated and minor slow payments indicated on the credit report.
- Collections, repossession, foreclosures and bankruptcies Credit reports also indicate public records such as collections, repossessions, foreclosures and bankruptcies. Though these items may indicate past credit problems, they sometimes have valid explanations. Underwriters may require a letter of explanation on items noted in the public records. Many times consumers have re-established credit and have an excellent payment history on their current obligations.
When the loan went into underwriting, they wanted me to explain an old (and I mean old) bankruptcy I'd had, and how I got my credit score up so high, how I'd protect myself in the future, and what did I learn from the whole experience.
Being a writer, and rather dramatic person, I wrote a tear-jerker letter of how I came back from a psychologically damaging marriage with no money to my name, went to college at 42 to get my first degree, worked any and all jobs to get myself through college, and began chipping away at my credit cards until I raised my score from probably the mid-400s to the low 700s. It took a long time, but I did it, and it still one of my proudest accomplishments. I learned your entire life can hang in the balance in the face of bad credit.
• Underwriting the Appraisal Generally, underwriters are not professional appraisers and do not re-appraise the property. They will review the appraisal to assure that it meets the requirements of the investor and sometimes request additional information to substantiate the value. They may request that a second appraisal or review appraisal be performed. A review appraisal can be completed from a site inspection or review of the written appraisal. In both cases, another professional appraiser will perform the review.
• Compensating Factors The underwriters consider many variables in their analysis. No two borrowers have the same credit and income profiles and underwriters use all of the information in the loan file to render a decision. Many times, borrowers fall outside the guidelines, but have strong compensating factors that reflect low credit risk. Some compensating factors are history of savings, long-term job stability, and history of making monthly credit payments that equal or exceed the proposed payments, a substantial down payment or a large cash reserve after the close of escrow.
• Final Credit DecisionAfter the underwriter has reviewed the entire loan package, there can be four outcomes:
- ApprovalIf the loan is picture perfect and the underwriter has no questions, the loan will be approved with no conditions.
- Approved with conditions (the most common response) There are two types of conditional approvals:
(a) If the underwriter needs additional documentation before a final credit decision can be made, a "prior-to-document" conditional approval will be rendered. In essence, the loan documents will not be prepared until the condition has been satisfactorily met. An example of a "prior to document" condition could be a pay stub to validate the borrower's income.
(b) If the loan can be approved, but a condition must be met prior to closing, a "prior to funding" conditional approval will be rendered. In this case, the loan documents will be prepared and sent to the closing agent, but the lender will not fund the loan until the condition has been met. An example of a "prior to closing" conditional approval could be proof of sale of existing home where the equity will be used as the down payment.
- SuspendedSometimes the underwriter will be unable to make a decision on a loan file because it is either incomplete or there are many unanswered questions. In these cases, the underwriter will ask for additional information from the borrower before an underwriting decision is made. An example of a suspension may be large gaps in the borrower's previous employment history and no tax returns to indicate the place of employment.
- Denial Underwriters will be unable to approve a loan if the loan file has substantial deficiencies and does not meet the minimum standards of the lender or the lender's secondary market investors.
It seemed an eternity that the loan was in underwriting - they'd come back for more information time and time again, and my lender would promise a certain date, then they underwriters (much like other government people we fear) would hold it up for some stupid little thing.
Underwriters may require a letter of explanation on items noted in the public records. Many times consumers have re-established credit and have an excellent payment history on their current obligations.
After closing was moved 3 times, I finally was told my final date. I was beside myself! I could get out of the hotel now! Try that for 7 weeks with three cats, two of whom hate each other. I almost gave up and made doilies out them.
Inspections, Expectations and Reality
I didn't know about all the inspections the house had to go through - I knew it had to have a "House Detective," but it had to have a "Sewer Detective" as well. It passed with only a few minor problems - the house was originally built in 1986, and the new addition in 2002. So of course you'd find things.
What made things worse was the owner had been a "fix-it-myself" type, and there were things that were dangerous, over- or under-wired, and just plain dumb in the house - some of which I repaired myself.
The sellers, unbeknownst to me, DO NOT HAVE TO REPAIR anything on the inspector's list. In the contract you sign, you can stipulate that repairs up to but not exceeding, a certain amount, be repaired by the owners. This is only a stipulation - if they refuse, you have 2 choices: accept it and fix them yourself, or walk away from the deal.
Since my stipulation was only $3,000, and they'd already thrown in a 60" wide screen TV and a $3,000 carpet allowance, I accepted their denial for fixing the house. Most of it was small, nothing structural, and electric, which I had a professional do.
Keys to the Kingdom
Finally, the underwriters were satisfied, the sellers were happy, their realtor was happy, and I was happy. I closed on my house August 15th, five days before my 51st birthday - what a gift!
It was a much more complicated than exciting process, but I learned a lot, made some mistakes (which I can fix after a year) and feel very proud I bought my own home - it is the American Dream, after all.
Summary and Caveats
With hard work, my eyes always on the prize, and Suze Orman's words ringing in my ears like a mantra -- "Pay off those credit cards!" -- I was able to buy my first real home.
Many years ago, after graduating college, I began to write a book on "How Every Child Can Graduate from a Four-Year University," having learned from the inside, and this is true if parents would the Pride Mobile and really listen to the school counselors when they talk about junior colleges as the entrance to a degree program. I graduated summa cum laude, after doing all my undergraduate work at the local junior college for 2/3 less than the four-year university costs.
Every person can, and should own their own home - it is more than a home; it is security, an investment and tax write-off. Do the work, and it can be your dream just as it was mine.
But there are things I learned that you should know:
1. "It's not the price of the horse, it's the upkeep." This saying is never truer than when it comes to owning a home - you now have water, sewer, trash, property taxes and homeowner's insurance to consider - not to mention that questionable water heater installed before California became a state.
2. Never overstate your income. Besides demonstrating a seriously bankrupt morality, it will get you in over your head, is illegal, and you'll lose that McMansion within a very short time. It is tempting (and I think one of the 7 Deadly Sins) to "enhance" one's income to be able to buy more home. And don't think your realtor won't be thinking, CHA-CHING. Pride can get you into a nice house, and hot water.
3. Location, location, location. Never buy a home thinking you'll live there forever. Chances are, if it's your first, you'll move in an average of five to ten years. Keep in mind:
- Resale Value - Is your home located in or near a growing city?
- Schools - Most people vie to be in the best districts -and will pay the price.
- Tax rate - Are you willing to give up City services for County tax rates?
I am thrilled with my home. I bought 9 miles from a city with an eye on gobbling up my area within five years - not to mention, in the meantime, I have an acre, space to work, fantastic neighbors, in a safe, quiet, and desirable location. May you be as blessed.