Applying for a mortgage loan to purchase a home is asking a lender to give you a pretty large chunk of change, based on your past track record of how you’ve repaid other lenders–your credit record. Because home loans are usually the largest debt that a person (or family) will have, and the money ultimately comes from investors, lenders have an obligation to those investors to adhere to certain lending principles, which were summarily ignored during the mortgage frenzy of recent years–resulting in today’s huge numbers of “non-conforming” or “subprime” mortgages, and the (predictable) number of borrowers facing foreclosure today.
These principles have long been referred to as the “Five C’s” of sound lending practices, that a lender will consider in reviewing your application:
Character. This looks to the integrity of the borrower; does he/she do what they have promised to do–which is to make payments on a specified date, on time? If you have a spotty credit history, this is already called into question. If your credit history is only a little off, it may help to provide records of timely rent payments, or to have your landlord write a letter giving a recap of a your paying habits. If a lender is willing to consider this at all, then the longer your relationship with this same landlord, the stronger the statement such records or letter will make. The type of debt you have may also be a factor–such as if it’s comprised largely of medical expenses–something you could not have avoided, and which are notorious for sending accounts to collection agencies, piling adverse information on credit reports. Or perhaps you faced a layoff at work, which put everything behind for a time but is a logical explanation (rather than an excuse), this will be considered as long as the situation has been rectified and your credit record reflects an effort to catch up. But if your credit is made up of car payments, boat payments, credit card balances, etc., and you have not made your payments timely, it could further cast a shadow over your Character as to good judgment in using credit appropriately, which brings us to . . .
Capacity–or, bluntly, do you have enough income to service this new debt? A rule of thumb, grandly ignored in the subprime mortgage frenzy, is that your house payment (including taxes and homeowner’s insurance) should not exceed about 1/3 of your gross monthly income, and added it to your existing debt, the total should not exceed 50% of that income. A little wiggle room can sometimes be given on these percentages if the borrower is relatively free of other debt.
Capital, or net worth. Do you keep savings on hand to enable you to meet a payment during a month when you are hit with an extra expense, such as a major car repair or medical expense? More importantly, have you amassed sufficient cash to come up with a solid down payment against the home you plan to buy (probably 20% if your credit isn’t sterling)? Lenders have learned the hard way through this mortgage breakdown that it’s important that mortgage borrowers have a substantial personal stake/investment in ownership of the home, large enough to keep them from walking away if things get a little tight. The home itself will provide the . . .
Collateral for the mortgage loan. Traditionally, this has been a winning proposition, with home values continually on the rise, sometimes gradually, sometimes dramatically. But this has become a slippery slope right now, with home values continuing to drop in most areas. While in the long term the values will eventually increase, this question mark on fixing the value of the home which secures the loan points up the need for a down payment, or investment by the borrower, so that lending institutions don’t find themselves “upside down” on the loan-to-value ratio as so many are today, leaving many borrowers locked into homes they can no longer afford, yet from which they are also unable to untie themselves since they owe more than the price they could get by selling the home in today’s market. Some financial institutions are willing to look into the possibility of what is called a “short sale”–writing off the difference, or a portion of the difference of the lost value of the collateral, in order to close out an ailing mortgage and allow the home/collateral to be sold to a buyer who qualifies for a new loan to purchase it.
Conditions are the final “C” in the five–both conditions of the economy and conditions of the borrower. The conditions of the mortgage lending economy are presently very tight. Although substantial funds have been earmarked for financing and refinancing homes due to recent “stimulus” funding, mortgage lenders are under the microscope to perform according to the book and invest in mortgages that meet traditional criteria for approval. If your conditions as a borrower–as laid out in the previous four “C’s” above–are in doubt, applying for a mortgage loan at this time doesn’t stand a good chance of approval. And since many lenders are now charging “application fees” of $350 to $700 (non-refundable or only partially refundable at best if the loan is not approved), it’s difficult to shop around. Plus, shopping around adds inquiries to your credit report, which further count against you there.
Unfortunately, your best plan for home ownership right now is to set up a savings account or CD to grow your down payment funds while you work on cleaning up your credit report. Make sure to pay your bills on time. If you have collections, you may already have paid some of them off. And if not, contact the collection agencies one at a time to see if you can negotiate to have to balance knocked down (can’t hurt to ask) and begin to get them paid off–once paid, they will be removed from your credit report. It takes a serious and time consuming phone-calling and letter writing campaign (prepare to be patient and not lose your temper), and checking back with the credit reporting agencies to be sure they do get removed when paid. It’s not an overnight process, but it’s your best bet given the amount of influence our credit reports seem to have over our lives these days.
Another alternative may be to contact a number of realtors to see if they have home sellers who are willing to sell on a Real Estate Contract rather than being cashed out right now with the proceeds of a mortgage loan (because if their home has dropped in value, there’s no “cash” involved). If you are truly in it for the long term, this could be a good solution for both you and a homeowner who finds himself “underwater” on the value of his home to what he owes. You might agree to simply take over his payments, or, if the mortgage company will not agree to reassign the loan to you, you might pay the current borrower directly, who will continue to pay the mortgage company. Over the term of your Contract, the home will almost certainly reach the value of the seller’s balance, so if your goal is truly to own the home (rather than trying to make money by buying and selling within one or two years, which isn’t happening right now) this could work out for both parties. Real Estate Contracts include a Deed from the present owner to yourself so that when the contract is fully paid, the Deed will finally put the property into your name. This course is not recommended without the oversight of a well-experienced realtor or escrow agent. The escrow company would hold the Deed and process your payments, and file the Deed with the appropriate county department when the Contract is paid in full.
Sorry to say, if your credit is under the weather or you lack a down payment, today’s economy does not make a good climate for seeking a home loan.
04.11.09
