We Found the Perfect Home... Now How Do We Pay For It?

Congratulations! You have found The One and are ready to make an offer. But hold on a minute... the seller and their realtor want to know that you are a "real" buyer. What does that mean? It means that you've been pre-approved by a lender. Now in reality, a pre-approval is not worth much, because a mortgage underwriter has not seen any documentation. Pre-approval is typically issued by a loan officer based on an initial mortgage application that may or may not contain accurate information. It does give the seller a warm and fuzzy feeling though.

The best thing to do would be to sit down with a mortgage professional and have them evaluate your income. Insufficient income or excessive obligations are two of the most common reasons for loans to be declined. An early analysis could avoid future anxiety.

There are several types of ways someone can be employed. The most common are salaried, commissioned, fixed income or self-employed, or sometimes a combination of all of them. If you are a salaried person, you typically receive a W-2 each year and a paycheck stub every week, two weeks or twice a month. Your pay period is important since it will determine your monthly gross income.If you are commissioned, you will need to supply your past two year's tax returns. The lenders will usually average the past two year's income to qualify you. If you are on a fixed income, social security disability, pension etc, you will need to provide documentation that the income will continue for at least the next three years. Some of this income can be "grossed up" by 125% if it can verified that it is not subject to taxes. If you are self-employed, you may either be a corporation or a sole proprietor. A sole proprietor files a schedule C with their federal tax return, while a corporation files a personal return and a corporate return. If this last scenario is the case, the lender will usually want to see two years of personal AND corporate returns. Once again, an average of the two years' income will determine an applicant's qualifying income.

In my previous article, I mentioned Fannie Mae, Freddie Mac and FHA. There are subtle differences in the qualifications that each of these look for when determining if an applicant is eligible for a mortgage or not. One determining factor is debt to income ratio (DTI). A lender will calculate an applicant's income in relation to the amount of debt they have, which will include the new mortgage payment. These debts are determined from a consumer credit report. The maximum debt ratio they allow is typically 45%. What that means is your monthly payments -- mortgage payment, car payments credit cards, etc -- cannot be more than 45% of your gross monthly income. FHA allows up to a 50% DTI. If your DTI is high, you may be advised to pay off some debts prior to loan submission, or possibly put more money down to lower the mortgage amount and monthly payment.

Lenders are now calculating payments on student loans, even if they are deferred, so you need to be aware of that. Another area of concern is unreimbursed business expenses. This is form 2106 of one's personal tax return. If a lender determines an applicant has unreimbursed business expenses they will consider that a debt and apply a monthly payment to it. This can have a serious effect on an applicant's DTI. Purchase transactions have been declined due to these, so be careful of taking this extra tax deduction if you plan on buying a house soon. Another potential income hurdle that may arise is a second job: lenders usually allow income from a second job only if an applicant has maintained one consistently for 18 months, even if it is not with the same company.

No matter how you receive income, you will need to document everything. The days of stating your income have long since passed. There are a few lenders that may still entertain these types of loan, but they require larger down payments, higher credit scores and liquid assets equal to roughly six months of stated income.

As always, the best advice is to speak with a licensed mortgage professional when beginning the home buying process. Be prepared. Bring your pay stubs, last two years' W-2 and tax returns, etc, to your mortgage professional and let them do the calculations. It's better to do this early in the process rather than after signing a contract to buy.

In my next article, I'll discuss credit scores and the effect they have, as well as ways to improve them.