Applying for a Home Loan

Income Items

  • W2 forms for the last two years
  • Most recent pay stubs covering a 30 day period
  • Federal tax returns (1040’s) for the last two years, if:
    • you are self-employed
    • earn regular income from capital gains
    • earn sizable interest income, etc.
    • earn more than 25% of your income from commissions or bonuses
    • own rental property
    • are in a career where you are likely to take non-reimbursed business expenses.
    • Year-to-Date Profit and Loss Statement (for self employed)
  • Corporate or Partnership tax returns (if you own more than 25% of the business)
  • Pension Award letter (for retired individuals)
  • Social Security Award letters (for those on Social Security)

Asset Items

  • Bank statements for previous two months (sometimes three) on all accounts. All pages, even if you don’t think them important.
  • Statements for two months on all stocks, mutual funds, bonds, etcetera
  • Copy of latest 401K statement (or other retirement assets because they can count as reserves)
  • Explanations for any large deposits and source of those funds
  • Copy of HUD1 Settlement
  • Statement on recent sales of homes
  • Copy of Estimated HUD1
  • Settlement Statement if a previous home is for sale, but not yet closed
  • Gift letter (if some of the funds come as a gift from a family member – the lender will supply a blank form)
  • Gifts can also require:
  • Verification of donor’s ability to make the gift (bank statement)
  • Copy of the check used to make the gift
  • Copy of the deposit receipt showing the funds deposited into bank account or escrow
  • Note: many get their statements of various kinds over the internet and these are not always acceptable to lenders, especially when the printed version does not contain the borrower’s name, account number, and the name of the institution

Credit Items

  • Landlord’s name, address, and phone number (if you rent – for verification of rental)
  • Explanations for any of the following items which may appear on your credit report:
  • Late payments
  • Credit inquiries in the last 90 days
  • Charge-offs
  • Collections
  • Judgments
  • Liens
  • Copy of bankruptcy papers if you have filed bankruptcy within the last seven years

Other

  • Copy of purchase agreement (if you have already made an offer)
  • To document receipt of child support (if you desire to show it as income)
  • Copy of Divorce Settlement (to show the amount)
  • Copies of twelve months canceled checks to document actual receipt of funds

copyright 2000 by Terry Light and RealEstate ABC

How Much Home can you Afford

Debt-to-Income Ratios

To determine your maximum mortgage amount, lenders use guidelines called debt-to-income ratios. This is simply the percentage of your monthly gross income (before taxes) that is used to pay your monthly debts. Because there are two calculations, there is a “front” ratio and a “back” ratio and they are generally written in the following format: 33/38.

The front ratio is the percentage of your monthly gross income (before taxes) that is used to pay your housing costs, including principal, interest, taxes, insurance, mortgage insurance (when applicable) and homeowners association fees (when applicable). The back ratio is the same thing, only it also includes your monthly consumer debt. Consumer debt can be car payments, credit card debt, installment loans, and similar related expenses. Auto or life insurance is not considered a debt.

A common guideline for debt-to-income ratios is 33/38. A borrower’s housing costs consume thirty-three percent of their monthly income. Add their monthly consumer debt to the housing costs, and it should take no more than thirty-eight percent of their monthly income to meet those obligations.

The guidelines are just guidelines and they are flexible. If you make a small down payment, the guidelines are more rigid. If you have marginal credit, the guidelines are more rigid. If you make a larger down payment or have sterling credit, the guidelines are less rigid. The guidelines also vary according to loan program. FHA guidelines state that a 29/41 qualifying ratio is acceptable. VA guidelines do not have a front ratio at all, but the guideline for the back ratio is 41.

Example: If you make $5000 a month, with 33/38 qualifying ratio guidelines, your maximum monthly housing cost should be around $1650. Including your consumer debt, your monthly housing and credit expenditures should be around $1900 as a maximum.

Step One – Calculating Your Monthly Income

When a loan officer prequalifies you, he works backwards to figure your maximum mortgage amount. You can do the same thing. The first step is to determine your monthly income. It isn’t quite as easy as it sounds. Lenders only count income they can document through paperwork.

If you are a salaried employee, and don’t earn bonuses, it’s easy. Get out your paycheck. If you get paid twice a month, multiply by two. If you are paid every two weeks, then you multiply by 26 (the number of pay periods in a year) and divide by twelve. Unless you’re a teacher. Teachers don’t always work year round and they have special rules.

If you are an hourly employee who works a straight forty hours a week and don’t earn overtime income, then it’s easy, too. Look at your paycheck, multiply your hourly rate by 40, multiply that total by 52, then divide by twelve.

If you earn overtime, bonuses, or commissions — it isn’t as easy. Lenders don’t give you credit for what you are currently earning. They average your income from those sources over the last two years, then add that to your regular salary or hourly monthly income. If you want a shortcut that is usually close, get out your W2 forms for the last two years. Add them together and divide by twenty-four. That is your monthly income.

If you are a teacher, a nurse, a seasonal employee, in construction, or earn only part-time income — you can use that shortcut, too. Add the figures from your last two years W2’s, then divide by 24. It generally gets you close.

If you are self-employed or receive 1099 income, then you need a two-year track record. Lenders go by what you declare to the IRS as income, since that is documentable. Since some self-employed people overstate their expenses, this may understate your income. Look at the Schedule C of your tax returns for the last two years and the number at the bottom that says “profit” is your annual income. You can add any depreciation to that figure. Add them together and divide by twenty-four.

There are variations and exceptions (like those who own their own corporations) but the above should cover most people.

Step Two – Working Backward

Once you have calculated your monthly income, multiply it by the back ratio for your particular loan. For generic purposes, it is fairly easy to work with thirty-eight. Take 38% of your monthly income or multiply it by .38. That tells you the maximum the lender wants you to spend on your housing costs and monthly consumer debt combined.

Now get out your bills and total them up to determine what you spend monthly on debt. Do not include your auto insurance or your utilities. Just creditors. For credit cards, use the minimum required monthly payment unless it is less than ten dollars. The rest should be fairly straightforward.

Deduct that amount from the total the lender wants you to spend on housing costs and consumer debt combined. Now you know the maximum the lender wants you to spend for housing costs, unless the figure is greater than 33% of your monthly income (there are exceptions, of course).

Step Three – a Little Guesswork

The next step requires a little guesswork. If you have a vague idea of what price you might qualify for, you can estimate what your annual property taxes and homeowners insurance might cost. From there, you can easily calculate the monthly equivalent. Subtract those figures from your maximum monthly housing costs total.

If you are buying a condominium (or an area with HOA fees), subtract out an approximate figure to cover homeowners association fees. What you are left with is your maximum principal and interest payment.

The Final Step – Almost

Now you have to go to a mortgage calculator (click here) and plug in some numbers. In the “payment” area, put the figure you just calculated. Plug in the current fixed interest rate. If you are putting less than twenty percent down, add a half percent to the rate to allow for charges you will pay for mortgage insurance.

Hit the calculate button and you should have your maximum mortgage amount. Add your down payment and you know your maximum purchase price.

Maybe. You may have to do some fine-tuning to zero in on the exact figure. Plus, lenders know how to “stretch” a client a bit higher if they need it.

Advice

If the figure is less than you expected (or need), lenders know programs that will help “boost” you higher in qualifying. Plus, they will do what you just did for free, they are much more experienced at the various nuances involved, and you will have no obligation to use them as your lender.

All you have to do is pick up the yellow pages and a phone.

copyright 2000 by Terry Light and RealEstate ABC

Buying a Home is a Good Idea

The Best Investment

As a fairly general rule, homes appreciate about four or five percent a year. Some years will be more, some less. The figure will vary from neighborhood to neighborhood, and region to region.

Five percent may not seem like that much at first. Stocks (at times) appreciate much more, and you could easily earn over the same return with a very safe investment in treasury bills or bonds.

But take a second look…

Presumably, if you bought a $200,000 house, you did not pay cash for the home. You got a mortgage, too. Suppose you put as much as twenty percent down – that would be an investment of $40,000.

At an appreciation rate of 5% annually, a $200,000 home would increase in value $10,000 during the first year. That means you earned $10,000 with an investment of $40,000. Your annual “return on investment” would be a whopping twenty-five percent.

Of course, you are making mortgage payments and paying property taxes, along with a couple of other costs. However, since the interest on your mortgage and your property taxes are both tax deductible, the government is essentially subsidizing your home purchase.

Your rate of return when buying a home is higher than most any other investment you could make.

Income Tax Savings

Because of income tax deductions, the government is subsidizing your purchase of a home. All of the interest and property taxes you pay in a given year can be deducted from your gross income to reduce your taxable income.

For example, assume your initial loan balance is $150,000 with an interest rate of eight percent. During the first year you would pay $9969.27 in interest. If your first payment is January 1st, your taxable income would be almost $10,000 less – due to the IRS interest rate deduction.

Property taxes are deductible, too. Whatever property taxes you pay in a given year may also be deducted from your gross income, lowering your tax obligation.

Stable Monthly Housing Costs

When you rent a place to live, you can certainly expect your rent to increase each year – or even more often. If you get a fixed rate mortgage when you buy a home, you have the same monthly payment amount for thirty years. Even if you get an adjustable rate mortgage, your payment will stay within a certain range for the entire life of the mortgage – and interest rates aren’t as volatile now as they were in the late seventies and early eighties.

Imagine how much rent might be ten, fifteen, or even thirty years from now? Which makes more sense?

Forced Savings

Some people are just lousy at saving money, and a house is an automatic savings account. You accumulate savings in two ways. Every month, a portion of your payment goes toward the principal. Admittedly, in the early years of the mortgage, this is not much. Over time, however, it accelerates.
Second, your home appreciates. Average appreciation on a home is approximately five percent, though it will vary from year to year, and in some years may even depreciate.. Over time, history has shown that owning a home is one of the very best financial investments.

Copyright 2000 by Terry Light and RealEstate ABC

Writing an Offer

Once you find the home you want to buy, the next step is to write an offer – which is not as easy as it sounds. Your offer is the first step toward negotiating a sales contract with the seller. Since this is just the beginning of negotiations, you should put yourself in the seller’s shoes and imagine his or her reaction to everything you include. Your goal is to get what you want, and imagining the seller’s reactions will help you attain that goal.

The offer is much more complicated than simply coming up with a price and saying, “This is what I’ll pay.” Because of the huge dollar amounts involved, especially in today’s litigious society, both you and the seller want to build in protections and contingencies to protect your investment and limit your risk.

In an offer to purchase real estate, you include not only the price you are willing to pay, but other details of the purchase as well. This includes how you intend to finance the home, your down payment, who pays what closing costs, what inspections are performed, timetables, whether personal property is included in the purchase, terms of cancellation, any repairs you want performed, which professional services will be used, when you get physical possession of the property, and how to settle disputes should they occur.

It is certainly more involved than buying a car. And more important.

Buying a home is a major event for both the buyer and seller. It will affect your finances more than any other previous purchase or investment. The seller makes plans based on your offer that affect his finances, too. However, it is more important than just money. In the half-hour it takes to write an offer you are making decisions that affect how you live for the next several years, if not the rest of your life. The seller is going to review your offer carefully, because it also affects how he or she lives the rest of their life.

That sounds dramatic. It sounds like a cliché. Every real estate book or article you read says the same thing.

They all say it because it is true.

Contingencies in an Offer to Purchase Real Estate

In most purchase transactions there may be a slight challenge or two, but most things will go quite smoothly. However, you want to anticipate potential problems so that if something does go wrong, you can cancel the contract without penalty. These are called “contingencies” and you must be sure to include them when you offer to buy a home.

For example, some “move-up” buyers often agree to purchase a home before selling their previous home. Even if the home is already sold, it is probably a “pending sale” and has not closed. Therefore, you should make closing your own sale a condition of your offer. If you do not include this as a contingency, you may find yourself making two mortgage payments instead of one.

There are other common contingencies you should include in your offer. Since you probably need a mortgage to buy the home, a condition of your offer should be that you successfully obtain suitable financing. Another condition should be that the property appraises for at least what you agreed to pay for it. During the escrow period you are likely to require certain inspections, and another contingency should be that it pass those inspections.

Basically, contingencies protect you in case you cannot perform or choose not to perform on a promise to buy a home. If you cancel a contract without having built-in conditions and contingencies, you could find yourself forfeiting your earnest money deposit.

Or worse.

Earnest Money Deposit in an Offer to Purchase Real Estate

After you have come up with an offer price, the next step is to determine how large a deposit you want to make with your offer. You want the “earnest money deposit” to be large enough to show the seller you are serious, but not so large you are placing significant funds at risk.
One recommendation is to make sure your deposit is less than two percent of your offered price. The reason for this is that if your deposit is larger than that, the lender will pay particular attention to how you came up with the funds. You might have to provide a copy of a canceled check along with a bank statement showing you had the money to begin with. Normally, this is not a problem, but if you have a short escrow period or are barely coming up with your down payment, it could pose an inconvenience.

Another reason to limit your deposit is “just in case.” Although significant problems are the exception and not the rule, they do occur. “Just in case” there is a nasty or prolonged dispute between you and the seller, the less money you have tied up in a deposit, the fewer funds you have placed at risk.

As with practically everything in real estate, there are exceptions to this rule, too. During a hot market there may be multiple offers on the property that interests you. A large deposit may impress a seller enough so they will accept your offer instead of someone else’s, even when your unknown competitor is offering the same price or slightly higher.

Since large deposits do impress sellers, you may also find that by making a large deposit you can convince the seller to accept a lower offer. More money up front may save you money later.

Copyright 2000 by Terry Light and RealEstate ABC

Buying A Home with Resale Value

There are many things that should be considered when buying a home. Since most homebuyers expect to buy a bigger and better home someday in the future, resale value is an important factor in decision-making. You use the proceeds from selling one home to buy the next one.

While no one can guarantee that your home will grow in value, there are steps you can take that maximize your potential gain.

“Location, Location, Location”

“Location, location, location,” is a common and almost hackneyed phrase in real estate literature. Your agent may even throw it at you when you ask for advice about buying a home. However, what does “location, location, location,” actually mean? Why repeat it three times?

Mostly, “location” is repeated to emphasize that it is extremely important to the resale value of your home. The idea is to buy a house that will appeal to the largest number of potential future homebuyers. A careful choice of location can minimize potential negative influences on future resale value, and maximize positive influences.

Focusing on resale value requires you to make several different “location” choices. The first choice you have to make is “which community?” At the very least, you should narrow your choice down to just a few local communities.

Copyright 2000 by Terry Light and RealEstate ABC