3 Conventional Home Loan Requirements You Need to Know – Video
Caeli Rigde: We’re going to go over a couple of things today. Specifically, we’re going to talk about the Fannie Mae 10 conventional loan spots. What that looks like in qualifications, from an underwriting perspective. We’re going to talk about some sequencing, interest rates, so let’s just go ahead and get going.
Let’s talk about qualifying for a conventional loan. Lots of moving parts in the process of a mortgage. Any of you who have gotten a mortgage in the last 12 months is very well aware, maybe even painfully, how different the playing field is from six or seven years ago.
The top three things that are going to be most scrutinized within this process are going to be: a debt-income ratio (also referred to as a DTI), credit score, and then your asset and reserve requirements. Let’s go over those one by one.
I think I’m going to go out of order. Just because the DTI requires the most explanation, I’ll save that one for last. Let’s talk about the credit score first.
Real quickly, for those of you that aren’t familiar with how credit scores work, I will just identify for you that there are three different repositories, that’s what they are called. You may be familiar with these names Equifax, TransUnion, and Experian, those are the three big boys they’re called repositories. From a mortgage leaning perspective, we are going to take the middle of those three scores.
Now, if you are a husband and wife team or partners purchasing a mortgage, we’re going to take the middle of the lesser of the two-party scores. In loan spots 1 through 4, we can go as low as a 660 middle score. I’ve actually seen even lower than that get approved, but there are compensating factors that would have to also be present to make that happen, I’ll go over that in just a second.
Now, Fannie and Freddie rules tell us that in loan spots 5 through 10, it is a hard and fast 720 minimum credit score. So, be mindful of that as you start inching up in the number of finance properties you have. There is no compensating factor that can get us around the 720. On an individual one-on-one basis, we like to take the time once we’ve done some pre-qualification work for you, to help look at the credit score, the credit report, show you how to read one of those silly things, and then further just help maintain what it looks like to keep those scores above the 720 as you start getting into that realm.
So that’s credit score, pretty easy stuff. Let’s talk about the asset and reserve requirements. The first thing I want to mention about this is that there is a difference between those two. Your assets, I’m referring to your cash to close. The reserve requirement is what is required to show an underwriter or an investor that you have an amount of available funds that we can show for the subject property and other rental properties that you may hold. So those are two different things, let’s talk about them.
First, let’s go into assets. Now, the assets, those need to be liquid. Those funds are what we’re going to show an underwriter that you have for your cash to close. Those funds also need to show a two month required seasoning period, so we’re going to ask for two months of your most recent bank statements of which the funds will be coming from. This is also important I want to add this, any deposit in an account that we have that we have supplied you an underwriter, any deposit that exceeds 25% of your gross income will have to be sourced and seasoned.
Knowing this in advance, I’m telling you right now, it will mitigate a lot of brain damage for you if you give us bank statements that don’t have that particular set of numbers in there. If you can avoid having deposits in an account that exceed that 25% of the gross income, it will make your life easier in the long run. Sourcing and seasoning, although not the end of the world, certainly, it’s just extra steps and hoops to jump through that we can avoid if we plan ahead. So that’s liquid funds.
Let’s talk about the reserve requirement. Now, conversely, these don’t have to be liquid. These can be for an example,401(k), or an IRA, or some other type of retirement account. They don’t need to show liquid and available like that. They can have penalties and things like that, it’s solely for the purpose of reserves. Now, the requirement for reserves is different from loan spots 1 through 4 versus 5 through 10 as you can see on slide notes [See Video 04:30].
Relatively benign in spots 1 through 4, the underwriters want to see six months of PITI that stands for principal interest taxes and insurance. If there are HOAs on the property that would also be included on our subject property. It’s six months of the PITI on our subject property, the one that you’re under contract that we’re purchasing now. Then, two months for each subsequent rental property, not to include your primary residence. We don’t have to count that one in that reserve requirement.
Then moving on to spots 5 through 10, it ends up being 6 months PITI per property. Six months of the PITI on all properties, going from 5 all the way down to 1 assuming they were all rentals, or 10 all the way down to 1, you need 6 months of PITI for everything. Again, it does not include your primary residence. Like I said, reserves do not need to be liquid funds. 401(K)s and things of that nature are just fine.
Let’s go back to the debt to income ratio. Now, I’m going to take a minute on this because I think that this is the one question that people tend to focus a lot of attention on, and they should. This is the biggest of the three that we’re talking about here. We can qualify a borrower up to a 50% debt to income ratio with compensating factors.
Let me quickly touch on the compensating factors and then I’ll discuss an overall view of how to calculate a debt to income ratio. Compensating factors to go as high as 50% DTI are strong credit scores and strong assets. If you possess both of those, chances are, we would be able to get you approved and closed on a loan with up to a 50% DTI.
General rule of thumb for that number, however, is 45% or less. So, keep that in mind. If you’re taking notes out there, maybe put down 45% if you know that your compensating factor for asset and credit score may not be on the high end. Otherwise, you’re looking at 45%.
Let’s quickly talk about how to calculate a debt to income ratio. I’m going to focus on a wage earner. The answer to calculating DTI on a self-employed borrower is far more complicated and that would be on a one-on-one basis, we would go over that with you.
For a wage earner, we’re going to take your gross income, we figure out what the monthly is, we take the annual and divide it by 12. We get your gross income, and we’re just simply going to multiply that number, most probably start with 45% being very conservative. With that number, let’s use for real example. Let’s say that your gross income is $10,000 a month. I’m going to take $4,500 of that, 45%, and that’s what I’m going use to start backing out the monthly debt.
The monthly debt is encompassing what is listed on your credit report. It will not include things like utilities on your home, or your cell phone bill, those sorts of things. It’s really going to exclusively be what we find on the credit report, plus the new liability we’re incurring with the purchase, the property PITI.
Now, in that scenario, the income from the subject property that you’re purchasing will be allowed to offset that new debt. As you’re doing this formula for yourself, just keep in mind, ideally you want to start conservatively and try to roll the entire new mortgage payment and subtracting it out of that $4,500 that we used, to see if the debt to income ratio is within that 45% range. If not, just keep in mind we are able to use 75% of the subject property rents to offset that PITI.
Let me go over a quick example for that. Let’s say that the gross rents are $1,000 a month, we can use $750 to offset what your current PITI might be. In this example, let’s say the PITI is $500 a month, I’ve got $750 in income for the property, and $500 in debt, leaving me with a $250 a month positive. Now, that $250 will go into the income column when calculating that debt to income ratio. Remember to add that back in if you’re going to try and take your hand at figuring out what your DTI is.
Clear as mud, right? Don’t worry, we will take the time to go over it with each of you individually as we actually get to the prequalification work. One of the things that we like to do is, I will personally take the time after the prequalification work and set up 30 or 40 minutes where we go into kind of a fact-finding mode. We start figuring out what your goals are, we take you through what your specific qualifications are as it relates to underwriting, and then we try to work the problem backwards so that we’re positioning you appropriately to support all those goals.
To review, the top three things that the underwriter is going to be looking at. Your debt to income ratio, what is your middle credit score, and they’re going to take a look at the asset reserve requirement.
What are some of the common reasons that loans don’t go through? Added or undisclosed debt. Let’s say for example, and this does happen. Not very often, but Mr. Smith decides to buy a car in the middle of our transaction. Lenders, just so that you know, or investors, will often pull a last minute credit report, even up until funding, to make sure that there’s no additional debt that they didn’t count in the debt-income ratio.
In the event that they were to find something added to the credit report, in terms of a monthly debt, that could be basis for denial and loss of the loan. Loss of job or income, obviously, in the middle of the transaction.
We’ve had another thing that happens all the way up until the end of the loan process, is the underwriters will call and do what’s call a verbal VOE, verification of employment. It has happened in my 15-year career, where come to find out at the 11th hour they just lost their job. That would be another reason that a loan wouldn’t go through.
Then lastly, and this is probably the most important, guys, and I think that for a lot of newer investors, especially, this isn’t always obvious to them. If for example, you’re buying multiple properties at one time, which happens, and you’re doing the loan through one lender and then you’ve got a loan through another lender, and you just didn’t realize that you have to disclose to one another. That’s a pretty big deal to investors and underwriters. The lack of disclosure shows off huge red flags.
The short answer on that is that it’s immediate grounds for dismissal of the loan. It will be canceled. I’ve even heard that they’re starting to put watch list for people that are non-disclosing their properties, if they’re second offenders and that sort of thing. It makes a big deal in the number of finance properties you have.
The reason this is such a big, big deal to them is that you’ve got people out there that are trying to maybe manipulate the system to leverage more than the 10 finance properties. Where they think that if they do two over here and two over there, or whatever the numbers, simultaneously, that it may not be caught, that they’re doing all those properties and closing sequencing them in such a way that they can end up with maybe 12 finance conventional spots.
I will just warn you right now that there’s lots of very sophisticated portals where, just based on your social security number, one for example called Lexus Nexus, they can find any open escrow anywhere in the country. I promise you, the lenders are looking for stuff like that. Not to say that there’s anything untoward going on from your perspective, just make sure that you’re disclosing all properties that you may be considering even, to whomever, whatever lender you’re working with.