Mortgage advisors often believe their clients are deeply concerned about the services they provide. They assume clients prioritize factors such as attentive listening, creative problem-solving, respectful treatment, empathy, competitive interest rates, low costs, smooth processes, and timely closings. Many advisors imagine having lengthy, in-depth discussions about mortgage options, benefits, risks, and costs.
However, this perspective may be misguided. A crucial insight in the mortgage industry is that homeowners and home buyers aren’t primarily interested in mortgages; they desire homes. The financing process is merely a means to an end, not the end itself. If given the option, most clients would prefer to pay cash and bypass the mortgage process entirely.
This reality can be challenging for mortgage professionals to accept, but it’s a fundamental truth of the industry. The financing aspect is rarely considered the enjoyable part of home buying, yet it’s a necessary step for most individuals. Mortgage advisors must reconcile themselves with this fact and focus on providing the best possible service within this context.
Typical questions that clients ask their mortgage advisors include:
- What is the maximum amount I can qualify for?
- How do I meet the qualifications for a mortgage?
- Which type of mortgage is most suitable for me?
- Where should I seek my mortgage?
- Why is this particular choice the best fit for my family?
- What do the various documents and paperwork entail?
These questions form the foundation of most client-advisor interactions in the mortgage industry.
Qualifying for a Mortgage
When individuals seek mortgage financing, lenders must first establish the applicant’s capacity and willingness to repay the loan according to the agreed terms. This assessment process can be broadly categorized into three main components, often likened to a three-legged stool: income, assets, and credit.
The income aspect involves verifying that the applicant has sufficient earnings to cover both the monthly housing payment and any existing debts. Assets are evaluated to ensure the potential borrower has enough funds for the down payment and closing costs, with some reserves remaining. Lastly, the credit history is scrutinized to confirm a pattern of responsible bill payment and overall financial management.
These three elements form the foundation of a lender’s decision-making process when determining an individual’s eligibility for a mortgage. Each component plays a crucial role in assessing the applicant’s financial stability and reliability as a borrower.
Income Assessment in Mortgage Qualification
A crucial factor in mortgage qualification is the applicant’s income. Lenders must verify that the potential borrower has sufficient earnings to cover all monthly bills, including the proposed mortgage payment, while still maintaining adequate funds for living expenses.
The Consumer Financial Protection Bureau (CFPB) has established guidelines stating that an individual’s total monthly obligations, encompassing both housing payments and other debts, should not exceed 43% of their gross income. Some loan types may permit exceptions up to 50%, but this generally represents the upper limit for most lenders.
When evaluating income, underwriters can only consider earnings that are documentable and meet specific criteria. The income must be deemed stable, predictable, and likely to continue. These terms carry significant weight in the assessment process:
- Stability refers to an established history of earnings in the applicant’s current job or field.
- Predictability implies that the lender can reasonably project the income to continue at a similar or higher level.
- “Likely to continue” is typically interpreted as income expected to last for at least five years.
These principles form the foundation of income assessment in real-world mortgage lending scenarios. Underwriters apply these criteria rigorously to determine an applicant’s financial capacity to manage the proposed mortgage alongside other financial obligations.
Income Types in Mortgage Qualification
W2 Wage Earners
For individuals employed as W2 wage earners, most underwriters consider their base W2 income plus the average bonus income over the past two years, provided they have established an employment history of at least two years. It’s worth noting that income from stock options or restricted stock units, common in areas like Silicon Valley, is generally not included in this calculation due to its potentially volatile nature, which conflicts with the requirement for predictable income.
Self-Employed Individuals
Self-employed applicants typically need to demonstrate at least two years of established, profitable business operations. For mortgage qualification purposes, their income is calculated as the net profit reported on tax returns, plus any non-cash expenses. This calculation involves adding back deductions that don’t represent actual cash expenses, such as depreciation and home office deductions.
Entrepreneurs who maximize tax deductions to minimize their tax liability may need to explore non-traditional loan options that use alternative methods of income documentation. These may include programs that assess business bank statements over one or two years to verify income flow, or loans that don’t require income documentation at all.
These alternative programs fall under the category of non-qualified mortgages, which don’t adhere to the Consumer Financial Protection Bureau’s established best practices. As a result, they lack some of the legal protections afforded to lenders for qualified mortgages. This increased risk for lenders typically translates to higher interest rates and costs for borrowers compared to conventional, qualified mortgages.
Other Income Sources
A variety of other income types can be considered for mortgage qualification, provided they meet the criteria of being stable, predictable, and likely to continue. These may include social security income, spousal or child support, dividend income, trust fund income, and others. Mortgage advisors recommend that applicants disclose any unusual income sources, as they may be eligible for consideration in the qualification process.
Assets Assessment in Mortgage Qualification
The evaluation of an applicant’s available assets for mortgage qualification is more complex than it might initially appear. While readily liquid funds in a savings account are straightforward to assess, other asset types require more nuanced consideration.
Investment Assets
For assets held in stocks or mutual funds through stockbrokers or money management firms, underwriters typically consider only 75% of the current value. This conservative approach accounts for potential market fluctuations and tax implications upon liquidation. Once these funds are liquidated and transferred to a bank account, 100% of the amount can be considered.
Gifts and Asset Sales
Funds raised through gifts or the sale of hard assets like cars or jewelry can be used for mortgage qualification, but strict documentation is required. Gift funds generally must come from close relatives and be genuine gifts, not loans. Lenders require documentation proving the donor’s ability to give the gift.
For asset sales, applicants must provide a clear paper trail demonstrating ownership of the asset, receipt of funds from the sale, and deposit of those funds into their account. Various types of assets, including cars, jewelry, motorcycles, heirlooms, and art, can be considered if properly documented.
Reserve Requirements
Mortgage lenders also require applicants to maintain a reserve of funds post-closing to cover potential emergencies. This typically ranges from three to twelve months’ worth of payments, including principal, interest, taxes, insurance, and any applicable HOA dues or mortgage insurance.
In summary, mortgage applicants must demonstrate sufficient funds for the down payment, closing costs, and reserves. All funds must be thoroughly documented, whether they are the applicant’s own savings or gifts from relatives. This comprehensive assessment of assets ensures that borrowers have the financial stability to manage their new mortgage responsibly.
Credit History in Mortgage Qualification
An applicant’s credit history serves as an indicator of their willingness to manage debt responsibly. While a comprehensive analysis of credit is beyond the scope of this discussion, there are several key elements that mortgage lenders typically look for in a credit report.
To understand credit assessment, it’s helpful to be familiar with some industry terminology:
- Tradeline: Any form of credit extended to an individual, including credit cards, car loans, student loans, and mortgages.
- Revolving account: A credit card that allows the user to charge, pay off over time or in full, and charge again.
- Installment loan: A debt with fixed monthly payments until the loan is fully repaid.
- Charge-off: When a lender ceases collection efforts and writes off the debt for tax purposes.
Generally, a favorable credit history for mortgage qualification should include:
- A record of timely payments on at least two tradelines for a minimum of two years.
- No late payments on revolving debt within the past year.
- No late payments on installment loans within the past two years.
- An absence of bankruptcies or charge-offs in the last four years.
- No foreclosures or short sales within the past seven years.
These criteria help lenders assess an applicant’s creditworthiness and reliability in managing debt obligations. Meeting these standards demonstrates a pattern of responsible credit use, which is crucial in the mortgage qualification process. However, it’s important to note that specific requirements may vary among lenders and loan programs.
Minimum Requirements for Conventional Mortgages
For individuals seeking a conventional mortgage with optimal or near-optimal pricing, certain baseline criteria must typically be met. These requirements encompass the three primary areas of mortgage qualification: assets, income, and credit.
- Assets: Applicants should have sufficient funds to cover:
- A down payment of at least 3% of the property’s valueAll associated closing costs
- Required reserves as stipulated by the lender
- Income: The applicant’s verifiable gross income should be at least 2.33 times their total monthly obligations. This ratio ensures that the borrower has adequate income to manage their mortgage payments along with other financial commitments.
- Credit: A minimum credit score of 620 is generally required.
It’s important to note that failing to meet these baseline requirements does not necessarily preclude an individual from obtaining a mortgage. However, applicants who fall short of these criteria may face less favorable terms. This could manifest as a higher interest rate on the loan or increased up-front costs associated with the mortgage.
These minimum requirements provide a general guideline for conventional mortgage qualification. They represent the threshold at which borrowers can typically access the most competitive rates and terms in the conventional mortgage market.
Selecting the Appropriate Mortgage Type
While the 30-year fixed-rate mortgage is often considered the standard choice, this perception is largely due to societal conditioning rather than universal applicability. In reality, the most suitable mortgage type varies depending on individual circumstances. Options such as adjustable-rate mortgages, 15-year mortgages, interest-only mortgages, or reverse mortgages may be more appropriate for certain borrowers.
The diversity of mortgage products available reflects the fact that no single solution fits all scenarios. It is crucial for borrowers to understand which type of mortgage best suits their needs and why. This understanding should extend to navigating interest rates and upfront costs, as these factors significantly impact the long-term financial implications of carrying a mortgage.
Ideally, the choice of mortgage should be driven by the borrower’s specific circumstances, goals, and concerns. However, many loan officers may lack comprehensive training in guiding borrowers through this decision-making process.
Many home buyers and homeowners tend to default to seeking a 30-year fixed mortgage with zero points without thoroughly considering alternatives. While this can be a suitable choice in some cases, it may result in unnecessary additional expenditure over time for others. The potential difference can amount to tens of thousands of dollars.
It’s important to note that there is no universally correct choice applicable to everyone. Instead, the emphasis should be on educating borrowers about their options, enabling them to make informed decisions based on their unique financial situations and objectives. This approach ensures that borrowers can select the most appropriate mortgage product for their individual needs, potentially leading to significant long-term financial benefits.
Selecting a Mortgage Provider
While there are numerous options for obtaining a mortgage, all providers generally fall into one of three categories:
Mortgage Brokers
Mortgage brokers serve as intermediaries between borrowers and wholesale lenders. Their role involves:
- Assisting borrowers in determining the most suitable loan type for their circumstances
- Ideally, shopping for the best lender on behalf of the borrower
- Submitting loan applications to the chosen lender
- Managing the process until the loan is finalized by the lender
Mortgage Lenders
Also known as mortgage bankers within the industry, these entities:
- Accept loan applications directly from borrowers
- Process, underwrite, and fund loans
- Typically sell the loans to a purchasing company or agency after closing
Depository Lenders
This category includes banks, savings and loans institutions, and credit unions. They:
- Operate similarly to mortgage lenders
- Originate, process, underwrite, and fund loans
- Usually have pre-determined buyers for the loans they originate
- Are subject to different regulatory authorities than mortgage lenders, which may result in slight variations in the borrower’s experience
Each type of lender offers distinct advantages and potential drawbacks. The subsequent sections of this discussion will delve into:
- The interrelationships between these different types of lenders
- The specific services each type of lender provides (and doesn’t provide) to borrowers
- How these factors might influence a borrower’s choice of mortgage provider
Understanding these distinctions can help potential borrowers make more informed decisions when selecting their mortgage provider, potentially leading to a more suitable and satisfactory lending experience.
