What Consumers Need to Know About Mortgages: What Consumers Need to Know, #1

By Dan Melson

A step by step guide that prepares you with what you need to know about mortgages as a consumer, tells you how to cut through the nonsense, what is important and what is not

Written by a working loan officer with wide-ranging experience and a decade of running a consumer education website, What Consumers Need To Know About Mortgages draws from a depth of experience dealing first-hand with issues that actual consumers have brought to the author for examination, together with common sense solutions that consumers can understand.

For the numerically inclined, calculations are included but not required for understanding

• Language: English
• Publisher: Dan Melson
• Release date: Jan 21, 2015
• ISBN: 9781386547129

Dan Melson

Dan Melson is married to the World's Only Perfect Woman.  They have two daughters in training for world domination.  They live in Southern California

Book preview

Basic Table of Contents

Section One Basic Things

Chapter One  About This Book

About Real Estate Loans / Precisely what is a residential real estate loan, and what are the major varieties?

Chapter Two Preparation

Two years in the same line of work / Paper trail on Assets / Paper Trail on Income / Methods of Income Documentation

Chapter Three  The Credit Report

What is a credit score / What is FICO / Who are Experian, TransUnion, and Equifax /How do you get a credit score? / What goes into a credit score for mortgages / Inquiries / Type of Credit / Length of credit history / balances / payment history

Chapter Four  Loan Qualification: The Debt to Income Ratio

about circumventing debt to income ratio / front end debt to income ratio / back end debt to income ratio / improving debt to income ratio / qualifying rate

Chapter Five   Loan Qualification: The Loan to Value Ratio

Property Valuation: Lesser of Cost or Market / Appraisals / some important loan to value ratios

Chapter Six  The Down Payment

Gifts / Income / retirement withdrawals / the benefit of leverage

Chapter Seven    Cash to Close

Section II  Things You Need to Know

Chapter Eight  Stuff You Need to Learn About First

Prepayment Penalties / Additional Payments and Paying a Loan Down or Off Early / Lowballing versus Junk Fees / Why you never really skip a loan payment / Impound Accounts / Shorter and Longer Term Loans / Loan Type, hybrid and balloon loans, and games lenders play with loan type / The Right of Rescission / Mortgage Loan Rate Locks /

Chapter Nine  Points: Origination, Discount, and Yield Spread

Computing dollar value of points / types of points / history of points / Compare loans based upon the bottom line to you / Yield spread / Why yield spread is not a cost to the consumer / law about yield spread does not correspond to reality

Chapter Ten  The Tradeoff Between Rate and Cost

Financial background / Closing costs vs. Discount/Yield Spread / Lower Rate means higher initial costs / Most borrowers will only keep the loan two to three years / time to recover initial costs / What happens if you choose high costs and low rate versus low costs and high rate

Chapter Eleven  Helpful or Interesting to Know

Note and Trust Deed versus Mortgage (and HUD-1) / Stick Built versus Modular versus Manufactured Homes / Why Do Lenders Sell Loans / Second (and Third) Loans and Subordination / Banker versus Broker versus Correspondent Lender / Portfolio Loans / Biweekly Payment Schemes / Debunking the Mortgage Accelerator Scam / Truth-In-Lending Advisory and APR vs. APY

Chapter Twelve  Major Government Loans and Programs

Federal Housing Administration (FHA) Loans / Veteran’s Administration (VA) Loans / Mortgage Credit Certificate (MCC) / Locally Administered First Time Buyer Programs

Section III  Application to Funding and Recording

Chapter Thirteen  Diving In

Don’t Change Anything / What can I afford / Never give a prospective lender your original documents / How far will my money and income go? /  nuts and bolts of computation and why / what computations of what you can afford need to include / Dangers to be aware of / Questions you should ask prospective loan providers / Pre-Qualification or Pre-Approval /  A Real Pre-Approval Letter /

Chapter Fourteen  Choosing the Best Loan For You

Conversations on Loan Terms / Compare Loans based upon the bottom line to you / What other loan types are there? / Another type of loan you might want to consider, and why / Unsustainable loans you should avoid / Never shop a loan or a property by payment / Loans are no longer locked upon application / Making an actual choice / Comparing Loans / How Long Will You Keep This Loan? / Comparing alternatives / purchase loans versus refinance loans / Don’t make a Deposit

Chapter Fifteen  After Your Choice

Monitor your loan for locking / Underwriter conditions and signing them off / What to do at Loan Closing / After Signing Documents

Section IV  Common Concerns

Chapter Sixteen  Games Lenders Play

Mortgage Advertising is horribly dishonest, and it’s not going to get any better / Why do lenders low-ball? / Online Mortgage Quotes / We’ll Beat Any Quote in Mortgage Loans

Chapter Seventeen  Cash Out Refinancing

Types of Second Mortgage / Refinancing your primary mortgage / Weighted Average Cost of Capital / Debt Consolidation Refinance – Doing it Wrong vs. Doing it Right

Chapter Eighteen  Miscellaneous Topics

Common Loanbusters / Cosigners / When the Appraisal is Below the Purchase Price

Chapter Nineteen  Final Words

Self-destructive behavior / Differences between loans are larger than they seem / In Closing

Glossary of Terms

Some Sample Thirty Year Loan Payments for Comparison

Chapter One

About This Book

This book is written with the idea of helping the general public understand real estate loans.  It is written from a perspective of being a loan officer and real estate agent.  While there are lessons of mindset and how to think that might assist a beginning loan officer or an experienced real estate agent herein, it is not intended to be a technical work or one that is capable of creating a finished loan officer by the reading.  In order to do that, I’d have to teach the ins and outs of processing, and that’s not the kind of book this is.  I’m also going to talk about the interactions of the loan process with the purchase process, but from a point of view of understanding loans.  Learning about what a buyer of real estate needs to know is a different subject.  This book is to learn about loans, not buying or selling real estate.

This is not about ‘get rich quick’; this is about ‘learn how to get better loans while spending less money.’  It’s also about how to put yourself in a position where your loan will be approved when you apply for it, and how not to sabotage your loan approval by something you might do without knowing any better.  What I’m trying to do here is teach an average person enough to understand the loan process, put yourself in a better situation before you start, and avoid the most common pitfalls, like the ones that caused the housing meltdown of 2005-2008, primarily on the individual consumer level.  Readers should also be far less vulnerable to the most common scams in the loan market.  While there is some general market material in this book, I’m always trying to show you how to make the most of your situation.  I will start by discussing how to prepare to apply, proceed to show how to calculate how much loan you can afford, how to shop, compare, and choose loans, and what to do between application and recording.  Notice I did not say approval or funding.  Neither of those marks the end of the loan process, and through my website (www.searchlightcrusade.net) I have had a large number of conversations with people to whom that was not explained, and they proceeded to kill their own loan through ignorance of this fundamental fact.  It wasn’t their fault – their loan officer should have explained it – but nonetheless the consequences were theirs to deal with.

The process can be byzantine, but is actually mostly intuitive and comprehensible when you understand how lenders and underwriters think, and how they make their decisions. Consumers don’t have to understand every dotted i and crossed t.  It is sufficient for consumers to understand a few basic thought processes behind it all.  I am going to explain the basics of what a credit report is, and how to improve yours.  I’m going to talk about how to make yourself eligible with even comparatively small down payments, and how to avoid things which are common ‘loanbusters’, or reasons that loans get declined.

I am going to repeat myself quite often and deliberately so.  Sometimes a new context will help you understand it better, sometimes repetition will help you remember it, sometimes you might just have skipped past it the first time without realizing the importance.  The goal is for you to have a decent comprehension – not of all the nuts and bolts – but of the basic functioning of the metaphorical engine and major failure points.

One thing to keep in mind during all discussions of real estate and real estate loans is that the amounts of money involved are usually large - the equivalent of somebody's salary for several years on every transaction. The temptation to fudge the numbers or even outright lie to get a better deal, or to get a deal at all, is strong. Many people don't think they're really doing anything wrong by fudging things a bit, but this is fraud. Serious felony level FRAUD. Fraud and attempted fraud are widespread. There are low-lifes out there who make a very high-class living at it (for a while). Every lender has to devote a large amount of resources to determining that each individual transaction is not being conducted fraudulently. To fail to do so would be to fail in their jobs to protect their stockholders and investors. I have told many stories about the most common sorts. But the reason everything in every real estate transaction is gone over with such a fine-toothed comb that adds thousands of dollars and much work to the cost of the transaction is that people lie, cheat and steal with such large amounts under consideration. Every hoop that anybody is asked to jump through has a reason why it exists, and often that is because somebody, usually many somebodies, have committed FRAUD based upon that particular point.  Sometimes the people committing fraud are the alleged professionals involved in the transaction, and sometimes, the legal issue of fraud can be avoided with the proper disclosure on one page buried in a stack of other disclosures.  So stay on your toes.

The idea behind this book is to improve your outcome.  How to make you, the consumer, end up in a better place.  How much better is a function of how much effort you care to put into it.  With the knowledge in this book, even minor amounts of due care will put you in a position thousands of dollars better off than without, and avoid most of the worst pitfalls that have cost millions of people anywhere from tens of thousands of dollars to their homes.  If you want to put in more effort, it can improve your final position even more, but the most important gains come from almost trivial amounts of effort at the right time.

About Real Estate Loans

The first thing to understand is that the entire machine of loans is completely impersonal.  I don’t mean that you’re necessarily just one more cog in the machine to your loan officer, as I can’t remember encountering a loan officer who thought like that.  But the mechanisms of whether your loan in particular is approved have precisely zero to do with whether you’re a good or virtuous person, whether you deserve a chance, or anything other than how well you fit the profile of someone who can repay this loan.  Understand that.  Your bank doesn’t give a damn if you’re black, white, brown, red, yellow, or pink with purple polka dots.  They care about green – money.  They don’t care whether you’re a man or a woman, what your sexual orientation is, or anything else.  They make their decisions based upon how well you fit the profile of someone who can repay the loan.  How much you make, how stable that income is, how much of that income is obligated to other payments, how well you manage credit and a host of other factors.  Except as I will note later, they don’t care how much equity is in the property.  Banks are not in the business of owning property, and they lose money when they have to foreclose no matter how much equity is in the property.  They’re in the loan business.  They care about whether you fit the profile of someone who will repay that loan.  Not having enough equity for the loan guidelines will lose you a loan, but having more won’t get your loan approved.  In the course of funding well over a thousand loans from dozens of lenders, I have never seen or heard race, ethnicity, sex, or orientation of the applicants mentioned in any sort of communication other than by government mandate for gathering the information.  If it weren’t required by the government on a mandated government form, I have precisely zero evidence that anyone at any lender I have ever submitted a loan to cares.  What they want to know is whether you fit the profile of someone who will repay that loan.

How do you fit the profile?  Earn a steady income from a consistent source.  Save enough for a down payment that fits the underwriting profile, which varies from zero to twenty percent or so.  Manage your credit well.  Make your payments on time.  Don’t try to borrow more than you can afford to repay.  Be able to document everything.  I’ll go over all of this in considerable detail later in the book, but the criteria are all financial.  The rest doesn’t matter.  The banks don’t care if you’re Democrat or Republican, statist or anarchist, or which way you put your toilet paper rolls in the bathroom dispenser.

Precisely what is a residential real estate loan, and what are the major varieties?

The next thing to consider is what type of loan I am talking about, which is a residential real estate loan, which is what most people mean when they say home loan.  Let’s take a moment to unpack what that means.  It must be secured by a residence in which someone is living or intends to live.  It must be a residence in which people can live, which in the states I’m familiar with means fully enclosed by walls and a ceiling, with heat, hot and cold running water, and some means for the disposal of waste.  In some places, there is a requirement for a full, functional bathroom with a bathtub. 

In order to be a real estate loan, there must be an interest in land.  Without an interest in land, it’s not real estate.  People may live in and own trailers, mobile homes and even fixed structures without an ownership interest in the land, but those are personal loans, not real estate loans.  Fractional interests and common ownership between multiple owners, as in condominiums, are still real estate.  Leasehold interests are usually real estate, but banks won’t allow the remaining lease to be shorter than the term of the loan.  Residences without an interest in the land are not real estate.  In fact, in every jurisdiction I’m aware of, when you buy real estate, you’re buying the land and the residence or other structure is included simply because it is appurtenant, or attached to that land by some physical connection more substantial than that’s simply where the wheels happened to stop.

Without these two components, a residence and an interest in land, you don’t have a residential real estate loan.  There are other kinds of loans for other real estate, and other kinds of loans for personal property, but the reason you want a residential real estate loan is that banks will make residential real estate loans on terms that are more favorable to the borrower than any other type of loan.  Long repayment periods, lower rates of interest, lower down payment requirements, and so on.  Unless I specifically state otherwise, from this moment forward, when I type ‘loan’ I mean ‘residential real estate loan’.

Within the category of residential real estate loans, there are many types of loans.  The very best are the so-called ‘A paper’ loans.  These are loans which are underwritten to the standards of Fannie Mae and Freddie Mac and typically sold to one of those two government run corporations.  The original lender may retain servicing rights, but the vast majority are sold.  These are built around you having decent credit, nice stable income, and a down payment of twenty percent or more.  There is an allowance for a lower down payment but it will cost you.  These loans typically do not have pre-payment penalties attached, but some lenders will add them.  At this writing, there is a movement afoot trying to disband Fannie and Freddie, based upon the fact they have cost the taxpayers hundreds of billions due to mismanagement while not being anywhere in the constitutionally enumerated powers of the federal government.  I have to confess to considerable sympathy in that direction myself, but if they are disbanded it will cause a rise in the costs of loans and will make it more difficult for consumers to get a top quality loan.

If you’re hearing talk about ‘conforming’ and ‘non-conforming’ loans, you’re dealing with ‘A paper’.  What they’re talking about is whether they conform to Fannie and Freddie’s standards in all particulars, or conform in all but loan amount.  There are standards for the biggest loans Fannie and Freddie will make, which they periodically revisit.  For a single unit property as I type this, the conforming limit is $417,000, but this is much larger than it was ten or fifteen years ago.  Conforming loan limits have no application to other types of loans except by decree of the lender or program.

The next three categories are about equal in quality, and very close to ‘A paper’ quality.  The first is the so-called ‘A minus’ expanded approval loans.  These are loans that are close, but don’t quite meet Fannie and Freddie’s most preferred criteria.  When I first started in the loan business, there were several tiers of these, occupying a niche between ‘A paper’ and subprime.  Most tiers of expanded approval have been discontinued, leaving only a very narrow shelf on the very verge of Fannie and Freddie’s core.  In fact, it’s so narrow that I have seen a second automated re-underwrite of the same file on the same basic information move customers into regular ‘A paper’ territory and I have seen them moved completely out of any approval at all.  Expanded approval loans are still funded with the idea of selling them to Fannie and Freddie – they’re the ones with the computer programs that are coming back with the expanded approvals.  At least when I’m doing it, I’m running the program with the idea of getting an ‘A paper’ loan for the clients but something causes it instead to be moved into expanded approval.  Expanded approval loans are very similar to regular ‘A paper’, with a little bit of extra cost.  But they are nail biters because if something forces a second pass with Fannie or Freddie’s automated underwriting program, it’s anyone’s guess as to what’s going to happen.

Veteran’s Administration, or VA loans, are a benefit for veterans of the US armed services and under some circumstances, their surviving spouses.  VA loans are not available to the general public.  The way they work is by emplacing a government guarantee against loss by the lender, which motivates the lender to be willing to loan against the full value of the property, or even a little bit more in order to cover closing costs.  The VA loan is the only loan available as I write this where there is (in general) no down payment required.  The drawback is that there are real costs which the borrower is not allowed to pay, so the other parties who are required to pay it if the transaction is to proceed tend to want higher compensation out of which to pay those costs.

Federal Housing Administration, or FHA loans, are available to most legal residents of the United States.  In general, unless you have defaulted on an FHA loan in the past or have defaulted upon a debt to the government, you’ll be eligible.  FHA loans have a minimal down payment requirement (3.5%), making them the most popular loans for first time buyers of real estate.  The downside is that there are costs to the FHA loan, not the least of which are a 1.75% funding fee and 0.55% rate surcharge for mortgage insurance on your loan.  There are also hurdles to jump before the FHA will loan on a given property, most significantly condominiums, and there are costs which the FHA does not permit a borrower to pay, so like the VA, people who have to pay these costs in your stead will ask for more money so that they come out even.

The next two types of loans are not currently available, but something like each of them are likely to make a comeback eventually.  The first is the so-called ‘Alt-A’ loan, of which the vast majority were negative amortization loans.  These had all kinds of friendly sounding names like ‘Pick a Pay’, ‘option ARM’ and ‘1% loan’, to name the most common.  These pieces of garbage were poison for pretty much everyone including the lenders, but that didn’t stop everyone including the financial press from pushing them like they were candy until suddenly the problems became too big to ignore.  The official story is these loans were supposedly intended for one very narrow and specific niche, but the one client I ever had who actually fit that niche couldn’t get approved even though I tried with multiple lenders, while forty percent of all loans being made were negative amortization.  So you look at the evidence and tell me how much truth you think there is in the contention these loans were intended for that niche.  Let me tell you folks, I’m pretty certain someone will bring them back eventually, but if I’m wrong and nobody ever brings them back I will not be in the least bit upset.

The second type of loan that isn’t really available right now actually does serve a broad and necessary niche.  So called ‘sub-prime’ loans and their lenders charge more than ‘A paper’ because the clients who need real estate loans and benefit from owning real estate may not fit the generic guidelines of Fannie and Freddie’s ‘A paper’ due to any number of factors ranging from non-traditional employment to poor credit.  They also included loans that allowed borrowers to do things traditional loans would not, such as extend the repayment period.  Sub-prime loans carried higher rates and costs and prepayment penalties that ranged from two to five years on average.  You could buy the prepayment penalty off by accepting a still higher rate, but most borrowers were stretching too much to accept any more of a rate boost.  Unlike negative amortization loans, sub-prime was not inherently bad, but irresponsible lender executives pushed by diversity activists in government eroded underwriting standards and ended up getting burned.  Currently, sub-prime loans face two hurdles to coming back.  The first is a comparatively minor regulatory hurdle which can be overcome in any of several ways.  The second is psychological – lenders and investors got so badly burned by sub-prime loans that they don’t want to make these loans.  I don’t think I’d had a lender’s representative tell me about a true sub-prime loan for over a year before the regulation discouraging them was even proposed.  They were trying to sell loans to people who could have qualified ‘A paper’ even though their rates and costs were higher and their terms less advantageous.  They didn’t sell many loans during that period – none through me.  Nonetheless, the market niche served by true sub-prime is real, and eventually some lenders will decide they want the profit that comes from serving it.  Just to make it plain, for those consumers who would benefit from these loans, the consequence of these loans not being available is that they don’t get loans, and therefore don’t get the benefit.

Sub-prime got – and gets – a lot of hate from the uninformed, and it was subject to abuse.  Nonetheless, it was a good niche to have available for both lenders and consumers.  To illustrate why, let’s ask what happens to someone who might have 50% equity in their property, but who has run into a rough patch.  If they still fit the ‘A paper’ profile, that’s great and away we go.  But if they don’t fit the ‘A paper’ profile and have a need to refinance for whatever reason – lowered income, their loan has hit the end of a fixed period, they have a partially amortized loan that has come to the end of its term, they’ve taken out a second mortgage and now the payment on that is adjusting to something unaffordable, any one of a number of other scenarios.  If sub-prime doesn’t exist and they don’t fit ‘A paper’, their choices don’t include refinancing.  They’ve either got to find a way to afford those payments, or sell the property.  Usually at bargain basement prices.  Often, they ended up in foreclosure.  And I have a fair number of borrowers I helped purchase a home with a subprime loan who are either still making those payments just fine today or refinanced into ‘A paper’ when their situation improved.

The final type of loan, bottom of the barrel for residential real estate loans, is the so-called ‘hard money’ loan.  Unlike all of the other types of loans listed above, these loans are made by private individuals, partnerships, and closely held corporations.  They don’t have to comply with banking regulations issued by the Federal Reserve because they’re not banks.  They don’t have to comply with securities regulations issued by the SEC because they’re not public corporations.  These loans are available currently, and if I understand correctly, the companies making them are doing very well.  They have high rates, the lowest I’ve ever seen being about twelve percent and going up from there, as well as upfront charges that start at about three percent of total loan amount, not to mention prepayment penalties.  They also have rather draconian requirements as far as equity is concerned – I don’t know of a single one that will currently go above seventy percent of the value of the property.  However, ‘hard money’ lenders do have the choice of lending to people and on properties that other lenders can’t touch.  Unsound or condemned property, property that doesn’t meet the requirements for a residence, and inability to document income being the most common niches for this kind of loan.  They’ll also foreclose hard and fast if the payments are not made on time.  Unlike regular lenders who will go to considerable lengths to avoid foreclosing, hard money lenders are typically interested in getting their money out of a non-performing loan fast.  Hard money loans are a bad option, and the only time I recommend them is to avoid an even worse one.

All of the above loans are designed to be first trust deed loans.  I will explain more about first versus second or third trust deeds later, but a thumbnail is that a first trust deed is paid first in the event of a default or foreclosure, while a second is paid after the first.  There are two loan types intended to be second (or subsequent) trust deeds.  They are the Home Equity Loan (HEL) and Home Equity Line of Credit (HELOC).  These are available from banks, credit unions, and internet lenders just about anywhere.  A Home Equity Loan is a loan against the equity in your home – a one-time lump of cash that you then repay in the fashion of any other loan, with set payments over a set term, with the very important difference that the loan is secured by a trust deed against your property.  A Home Equity Line of Credit is similar, but it works like a credit card for a limited time period.  Instead of a single lump sum payment of cash, for a limited time you can write checks up to the limit that was approved in the line of credit.  If you pay it down during the draw period, you have the money once again available to you.  Once the draw period has expired, it becomes essentially the same as a Home Equity Loan – you can no longer take withdrawals, and the payment is calculated as if your balance when the draw period expired was a lump sum loan.  Both Home Equity Loans and Home Equity Lines of Credit are available on a wide variety of terms, and can have very low costs associated with them, occasionally making them more attractive than loans intended to be used for first trust deed loans for low dollar amounts.  If you were intending to put a down payment of $450,000 on a $500,000 property, it is likely that a home equity loan or HELOC would be something you should seriously consider.

Chapter Two

Preparation

Getting ready to apply for a real estate loan can take quite a while, depending upon how you’ve been handling certain things beforehand.  If you’re sure you’ve got a sterling credit score, your documentation is all in order, and you make more than enough to qualify, preparation can be done with as fast as you can make a decision to apply for the loan.  If, however, one or more of these things needs some massaging on your part, your preparations may need to be more extensive.

Two years in the same line of work: The first thing you need is two years – as in 24 months or 730 days - in the same exact line of work.  Not changing from ‘engineer’ to ‘sales manager’, or vice versa.  Not changing from a W-2 employee to self-employed contractor (sometimes going from contractor to W-2 employee can get approved.  Not always.)  If you’re with the same employer, a progression can also be approved, for instance going from ‘salesperson’ to ‘sales manager’ or ‘vice president’.  If your salary went up, it will be averaged over the two year period, but getting a promotion doesn’t disqualify you.  Even changing employers with a promotion can be approved if your new position is in the same line of work, but going from the counter at McDonalds to being a manager at Sears is not same line of work.  At that point, the lenders are going to want to see two years as a retail manager.  This cannot change during the loan application process, either.  Once upon a time, I had someone I gave my standard ‘don’t change anything’ spiel to when he applied for the loan and he didn’t realize I really meant don’t change anything.  He quit his job as a programmer to work as a contractor.  He already had a contract with his former employer paying him more than he’d previously been earning, but he no longer had two years in the same line of work.  End result: no loan.  Not with that lender or any other.  I get explicit about no changes in your employment situation now.  You need two years in the same exact line of work.

There is an exception for two years in the same line of work, and that’s if you retired.  All you’re going to be able to use is your retirement income, but that income isn’t going away.  You did your time, you earned that pension, and now you can’t be fired.  Looked at from the proper point of view, it means you’re guaranteed to be in the same line of work for the rest of your life.  Mind you, if your company goes out of business and doesn’t pay your pension you’re probably not going to have the money to pay your mortgage, but that’s a different issue.  Right now the company that owes you the money is doing fine, so providing you can document your pension adequately, you’re fine.

Paper Trail on Assets: Probably the easiest thing to take care of for most people is to arrange a paper trail on your assets.  Any asset that you want to use in your down payment needs to be sourced or seasoned by a minimum of six months.  Sourced means that you can document where the money came from and how you got it.  If you sold real estate, there will be a specific form to show how much your proceeds were. If you sold something else (I’ve had clients who sold significant personal property) you want receipts or copies of the payment advice that enumerate precisely what you sold.  If your down payment money is coming from bank or investment accounts, you want statements showing that the money has been in there for at least six months, although it’s fine if you’ve been making regular deposits every month.  Six months ago it was fifty thousand, but you’ve been making regular deposits of five hundred dollars per month and you had good investment results so now you have sixty-five thousand in the account?  That’s very believable to underwriters.  The deposits and results all show a paper trail of when and how much. 

What isn’t believable is a large number of dollars for which you cannot show a paper trail.  Indeed, any such assets that the underwriter can discover, whether you’re using it for a down payment or not, must show sourcing or seasoning.  If you cannot do this, the underwriter will assume you got a loan.  I’m not going to tell you such loans are never permissible, but the underwriter is going to want to see a copy of the paperwork including the payment schedule.  Most such payment schedules will raise your debt to income ratio beyond the maximum permitted by underwriting guidelines, and your loan will be declined.  An underwriter’s favorite phrase is, Show me on paper, by which the underwriter means show a written attestation from a third party of what you are claiming.  If you cannot do that, the underwriter will decline the loan.  Not all third party attestations are acceptable.  For instance, if you’ve been paying rent to your parents, the underwriter is not going to accept their word for it.  They’re going to want to see at least six months of cancelled checks, cashed in a timely fashion.  Similarly, friends’ letters and similar documentation will likely be disbelieved.  I once had to go five echelons up a lender’s corporate chain of command to get approval of a loan where my client had tenants who had been renting out a property he owned in another state for years, but my client had rashly elected to accept a cash deposit rather than requiring it to be paid by check.  Mind you, we had the statement showing the deposit, and statements showing regular monthly receipt of the rent for all that time as well as rental receipts.  But because my client had accepted a deposit in cash, the underwriter did not want to believe it was a legitimate rental.

Get your head around this fact: All of the money you have needs to be documented with a paper trail showing that you’ve had it for at least six months, or failing that, exactly how it came to be in your possession.  Otherwise, the fact that your loan will be rejected is as inevitable as gravity.  If you cannot show such a paper trail, you need to wait until you’ve had the money and can show a paper trail on it for at least six months.  Mind you, the underwriter can always ask for more, especially if something about the situation strikes them as fishy.  But I can make an absolute iron-clad guarantee that they’re going to want to see that paper trail going back at least six months.

Paper Trail on Income: For most people income documentation is also pretty straightforward – you’re going to have a W-2 or 1099 showing what you made last year, and payment stubs showing what you’ve been paid so far this year, always including your last thirty days’ worth of paystubs.  If the paystubs don’t have year to date pay information on them, you’ll need every single one of them for the year.  Maybe it’s more than one such form, maybe you’ve got multiple clients or multiple employers, but such situations are still a relatively straightforward application of the basic principle.  Income documentation must cover an absolute minimum of seventeen months, so early in the year, you may need to have two prior years of such information.  For certain professions – the self-employed and construction being the classic examples – you will always be required to submit a copy of your complete federal tax forms for the relevant years.  The forms must include all of the forms you filed with the IRS, and must be signed.  You’re going to hear this so much that you get tired of it, but the underwriter can always ask for more documentation.  They can ask for a copy of your taxes even though you’re a W-2 employee who gets precisely the same paycheck for the same work every two weeks.  They can ask for a longer period of income documentation.  They can ask for more documentation that you actually made the money.  They can ask for all sorts of things, and decline your loan if you don’t comply.  But this is the absolute minimum they will ask for.  Absolutely, positively, guaranteed.  They rarely ask for more, but when it happens, we’ve got to get it for them.  If you haven’t filed your taxes even though it’s after April 15th, they can require that you file your taxes as well.  For advanced students, this can have other effects upon your finances and affairs, but for beginners looking to get a loan so they can buy their very first property, all you need to understand is that if you’re required to show the underwriter your taxes after April 15th, you need to file your taxes before the loan can be approved.

Once upon a time, there were other methods of income documentation available for loan applicants.  I am firmly of the belief that these methods or something like them and intended to fill the same niche will return eventually.  The most logical, which was available for subprime loans only, was twelve or twenty-four months of checking account statements.  They’d count the money coming into the account, discount it by twenty to thirty percent, average it over the time frame, and use that as your monthly income.  This is not currently available simply because subprime loans are not currently available.  Also, the government isn’t real thrilled about this method of documenting income because it caters to the parts of the shadow economy that prefer not to pay taxes.  But I anticipate that when real subprime loans return, so will this method of documenting income.

The other two methods of documenting income aren’t really documenting it.  The first, stated income, allows people to state their income, and in return for a slightly higher rate to justify the additional risk, the lender agrees not to require income verification, but only source of income verification.  In other words, they’d check to verify that you were, for example, a salesman for medical widgets, but not require you to document how much you were actually paid.  There were caveats, such as requiring a salary figure that was believable for your occupation in your area.  You couldn’t claim to be making $250,000 per year working the counter at McDonalds.  The general safe harbor is the 75th percentile of what people with the same job title were making in your area, and yes there are statistics for that available.  An additional requirement for stated income is having liquid assets – cash or cash equivalent – capable of paying your bills for at least six months.  This is only good sense.  They want to know you’re not scraping the bottom of the barrel and holding on with your fingernails as far as ability to live within your monthly income.  They want to see that you’ve got something put aside.  If you were making what you said you were making in order to qualify, you should have it.

Finally, at least in the ‘A paper’ world, you had to have some pretty significant equity.  Historically, these programs required 25% equity or 25% down payment.  Even during the height of insanity, I don’t think I ever saw an ‘A paper’ stated income program that required less than 20% equity.  Sub-prime stated income went to 100% during the period I like to call the Era of Make Believe Loans - in return for much higher rates and pre-payment penalties.  If you understand the role sub-prime filled, this was precisely appropriate – accepting more risk in return for more return.

The final method, NINA (short for No Income No Asset verification), you didn’t even state an income, and your loan rate was determined entirely by your credit score and equity.  You pretty much had to have at least 25% equity to do a NINA loan.  Some people called them ‘ninja’ loans, but I thought the baby on a show I used to watch occasionally summed it up much better: "Here I