7 hurdles to the lowest-rate mortgage, and how to clear them
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Home prices are possibly bottoming out in many markets, according to a recent forecast by Zillow.com, which tracks the value of more than 100 million U.S. homes. So now may be the time for buyers to think about getting into or re-entering the market and for owners to consider refinancing to a lower mortgage rate.
There is still the matter of today’s tighter lending standards, which can be daunting. “The four horsemen of today’s tougher underwriting to qualify for the best rates are documented income, a high credit score, a significant down payment, and a low debt load,” says Keith Gumbinger, vice president of HSH Associates, a New Jersey-based publisher of mortgage and other lending rates.
Here’s how to clear seven hurdles between you and the lowest possible rate.
1. Self-employed
After the irresponsible lending practices of the housing-bubble era, lenders now expect you to fully document everything, starting with your income and assets. That’s not a problem for salaried employees, who can easily produce W-2 earnings statements, but it’s not always easy for the self-employed.
Solutions. Dig out your annual and quarterly estimated federal income-tax returns from at least the past couple of years to prove your Schedule C earnings. You’ll need to produce several years’ worth to document consistency in your income and field—the more, the better. Wage earners would also be wise to produce several years of tax returns if they’ve had a recent employment gap. Statements from investment and bank savings accounts can also document your assets, along with property deeds and appraisals.
2. Credit score below 740
Most lenders require a minimum FICO score of 740 to get the best rates, and some want an even higher one.
Solutions. Comb through your credit reports from the three major credit-reporting bureaus—Equifax, Experian, and TransUnion—to root out errors that unfairly hurt your score. (To request copies of your free reports, go to annualcreditreport.com.)
Look for black marks whose reporting time limits have expired, paid-off loans not reported as such, lower credit limits than you actually have, collection items that need attention, and unfamiliar accounts or derogatory items resulting from identity theft. Dispute and fix anything that’s not right. Your credit score will improve as soon as the credit bureaus clean up and correct the information.
Are you still short on your score but on the straight and narrow with good payment habits? Be patient. The FICO scoring model penalizes bad behavior less as it recedes into history as long as the new reports show that you pay your bills on time. Paying down debt is another way to boost your score.
3. Carrying too much debt
Traditional lending criteria limit the size of your monthly mortgage payment to 28 percent of your monthly gross income. Total household debt payments (including mortgage, property taxes, and home insurance) shouldn’t be more than 36 percent. The lowest rates are reserved for borrowers who come in below those targets.
Solutions. Launch a two-pronged attack by boosting your income, if possible, and paying off your debt. For example, a nonworking spouse can return to the job market, or you can take on a part-time second job, work overtime (if your employer pays it), or turn a hobby or special skill into income. On the debt side, avoid taking out any new loans or opening new credit-card accounts. Put off big purchases like cars, electronics, or appliances, if you can. Apply any new income to accelerate the paying down of your existing debts, which gives your balance sheet a double kick—income up, debt down.
4. Less than 20 percent down
“The old rules are back,” says Brad German, a spokesman for Freddie Mac. He’s referring to the traditional, pre-bubble mortgage standards known as the four C’s: credit, collateral, capacity, and capital. A down payment is the cash portion of collateral that you put at risk, along with the property’s appraised value, which the lender can grab if you stop paying your mortgage.
Solutions. Redouble your savings efforts to beef up your down payment. If you have the option, sell less-liquid assets (a parcel of land, a boat, art, collectibles) to build down-payment money, and keep more-liquid assets (CDs, mutual funds, stocks) to meet lenders’ higher cash-reserve requirements (see No. 7). Of course, be mindful of any tax implications of turning tangible assets into cash.
You can also borrow from your 401(k). You’ll have to report it on your application, and the payback amount becomes a commitment against your available monthly income in calculating how much of a mortgage payment you can afford. First-time homebuyers younger than 59½ can take up to $10,000 from an IRA to put toward a home purchase without owing the 10 percent early-withdrawal penalty.
Gifts are OK, but your benefactor will need to sign a notarized gift letter swearing that no repayment is required.
5. Current mortgage is under water
If you want to refinance to make your home payments more manageable but your existing mortgage is bigger than your home’s market value, you’ll be stymied by problems No. 3 and No. 4.
Solutions. If your mortgage was sold before June 2009 to the Federal National Mortgage Association (Fannie Mae) or Freddie Mac, consider the Home Affordable Refinance Program. “HARP 2.0 is a very sweet deal if you can get into it,” Gumbinger says. You can refinance a mortgage as much as 50 percent larger than your home’s value. Borrowers need only prove that they have an income (no minimum amount is stipulated) and that they have been making payments on time. They don’t need to have a minimum credit score, and a property appraisal is not required.
If your loan isn’t owned by Fannie Mae or Freddie Mac, you don’t qualify for HARP. But you may qualify for other assistance programs. You can get more information on all these options by going to the Making Home Affordable website, a joint program of the departments of the Treasury and Housing and Urban Development.
6. Denied by one or two lenders
Mortgage standards are fairly consistent across the marketplace and from lender to lender. But don’t despair if the first couple of lenders reject you or offer you rates that are higher than you’d like.
Solutions. It still pays to shop around, because lenders write a certain percentage of mortgages to keep in their own portfolios with no intention of selling them to Fannie or Freddie. Find out what went wrong and fix it, if possible. Then shop at banks, savings and loans, and your credit union, if you belong to one.
Mortgage brokers who survived the housing collapse have access to funding from private investors. Find a good one through referrals by co-workers, friends, and your real-estate agent, or search for a certified mortgage broker through the National Association of Mortgage Brokers.
7. Low post-closing cash reserves
Some lenders now require that you have cash reserves and/or easily liquidated property or investments equal to six months’ carrying costs—up from two—after you close the purchase, in case you suffer future financial problems.
Solutions. Lenders are looking for cash on hand or easily liquidated assets. Those include bank deposits and CDs, mutual funds, and even the cash value of your life insurance. Seventy percent of your vested retirement savings can count, too. But keep in mind that any loans from your plan count against those assets.
Putting together a sizable down payment and strong cash reserve can be difficult. If you’re having a tough time, you may need to lower your sights or sharpen your negotiating skills, or both. Focus on finding a home whose total price you can afford. That means you’ll need to have saved 20 percent for the down payment, plus more to cover closing costs and cash reserves for emergencies.
