Recently we explored Goal Setting that is conversational vs transformational.
And if your goal is to buy a home in 2020, then you know that is really the outcome you want – to own your own home before the ball drops ringing in 2021. And the goal, this time, if multi-faceted. What’s more, every day you will have to make some progress on each part of the goal to reach the outcome of owning a home.
First, let me state it for the record. You can achieve the dream of owning your own home.
I and others are here to help, so count on us as a resource along the way. And count on us to celebrate with you when you do achieve your dream.
So, here are the areas to focus on to be moving into your home: income, savings and credit.
Not overwhelming. But I’ll bet one of those simple words made you break out into a cold sweat. Don’t worry, we can get there. Let’s open up each area and break it down.
As a lender, we want to see a two year history of work – or study for the work you are doing now, if you are recently out of college or tech school.
Once the two year work history is established, it does not matter nearly as much how long you have actually been on your current job, if you are a W2 employee – meaning you work 40 hours a week for a set salary or hourly wage. You see, a W2 position is the easy one. We look at today forward to see income, as your income is predictable.
So, assuming we have documented a two year history of work in that or a similar field, you are good – even if you are switching jobs and have not started the new job as you make loan application for the home loan. We just get the offer letter detailing pay, start date, position, etc and use that to qualify you. Then, once you do get the first paystub, we will ask for that…at times even after closing on the home.
The exception to this is when you have had a significant gap in employment in the past couple years. Recently I was working with a home buyer who had been in a motorcycle accident, and between surgeries and rehab, had been out of work for some 8 months. Thankfully, he was back on his feet when I met him and back to work. And, I know you’re wondering. No, he did not buy another bike.
We did, however, have to have a history of six months on the job before we could close on his new home. Why? Simple. Think like a lender for a moment and imagine you are considering loaning someone $250,000.00 of your own money so that they can buy a home. You, too, would probably want to see that everything is good and this new friend you are about to loan money to is fully back, working for a while and can, therefore, be successful in paying you back the $250K, a bit every month. Fannie Mae and FHA, the lender, has set that time to get comfortable that the buyer will be able to successfully pay back this loan and keep the home at 6 months back in the workforce. Reasonable, right?
In this new gig economy, however, not everyone is a W2 employee.
So what happens with the contract employee, the waiter relying on tips or the business owner? It is not so simple, as the lender cannot predict the future income like we can when a home buyer earns $22/hour.
We approach it differently, by looking backward. We average the past 2 years income, divide by 24 (months), and say that is the reasonable historical income we can count on that you should have to be able to successfully pay back this home loan. Reasonable, as well.
Okay, sure. But what about that ‘self-employed’ buyer whose accountant is a genius when it comes to preparing income tax returns – and saves her a whole ton of money that otherwise may have been owed to Uncle Sam?
Simple. We have a solution for that as well. A portfolio loan. For that self-employed person looking to buy their home, we gather 12 months’ bank statements, count all the deposits from the business (yes, we exclude that one-time deposit of the proceeds from the sale of that boat. Best two days in a man’s life is the day he buys the boat, and the day he sells it. A good day; but not recurring income. So we exclude that one.)
The deposits, or at least 80% of them, equal income from the business. Most portfolio programs using bank statements allot 20% of the deposits to costs of operating the business, and exclude those.
So, 80% of the deposits over 12 months are added up, divide by 12, and we consider that your average income to be able to pay back the home loan. Easy. And no tax returns are requested at all. Oh, do expect a higher interest rate, as this loan is not sold to a government supplier of home loans like Fannie Mae or Freddie Mac – but to a hedge fund. They will make the loan, but will want a higher return on that loan. So expect 2-3% higher than the going rate for a Conventional, Fannie Mae 30 year fixed rate loan.
Any questions on income? Shoot me a message here.
Down payment, closing costs and reserves make up the assets that the lender needs to verify.
And the biggest misnomer is the down payment. A common misconception is that 20% of the purchase price is required as a down payment.
Not at all.
3% of the purchase price is required on conventional loans. So a $300k purchase would require $9,000 down payment.
3.5% on FHA loans, or $7,000 on a $200K purchase price.
Then, $0 down payment on VA and USDA (i.e. rural housing) loans. VA, of course is only available to active duty military, veterans and certain reservists. Likewise with USDA loans, where the property must be considered ‘rural’ to qualify, and there are household income limits that vary by county.
So, for most home buyers 0-3.5% down payment will suffice to qualify for a home loan.
The down payment can come from a gift from family, as well as from the buyers’ own funds. So if your goal is to buy a home this year, but the one element holding you back are coming up with the necessary down payment, then your goals are simple – save enough to buy that home.
The income from your employment is used to qualify for repaying the home loan. But the down payment just needs to be there, in your account. A few quick ideas to come up with the down payment, if that is what is holding you back:
- First, look at your budget, and see if there is anything you can trim to help save a bit more every month and accumulate the amount over time. Nearly all of us have some areas that can be cut, depositing the difference in the ‘home purchase’ account.
- Then, I work with a lot of home buyers that will take on extra gigs for some time, and save all of that money earned toward the home purchase. I have worked with people who do everything from delivering pizzas for a while to dog walking to building and selling corn hole boards. Even a part time job for 6 months in the evenings. And, the sky is the limit of course.
- Sell something. That boat that you rarely use, the motorcycle, the old record collection…you know, anything that has value to another that will help you beef up your funds. If you do sell something that has a title, such as a motorcycle, keep the paperwork – a copy of the title, the bill of sale that you generate and the copy of the source of funds the buyer used to pay you. Perhaps the Paypal receipt, for example.
- Gift funds from family. It is common that family will want to help with the purchase of your home, and may want to give you a gift to help.
- Borrow against a 401K, which is another common source. Just be careful here to borrow against the balance rather than withdraw the funds directly. The latter will carry heavy penalties and taxes due in most cases.
- Freddie Mac has a neat new grant available to home buyers who use a conventional home loan to buy, with a grant of $1000, $1500 or $2500 to help with your down payment. The buyer on the loan application will have to be under 50 or 80% of the area median income. Here is a quick link to lookup the area median income to help judge whether you qualify for this one.
- And, there are some grants from States or counties that can help with the down payment. A word of caution here, as some are very good while others add a significant amount to closing costs and are repayable if you sell or refinance in a certain period of time.
If your goal is to buy a home, I recommend we talk to see what you most likely qualify for, so that you can have that savings target in mind to cover the down payment.
On top of the down payment, you will have closing costs. Figure 2% of the purchase price in most cases; 3% for a portfolio loan. And, it is quite common that the seller, when negotiated, may agree to pay all or part of the closing costs.
Finally, in some cases you may need ‘reserves’. The requirement depends on the loan type and a whole lot on credit score. And the typical requirement, when reserves are needed, is an amount equal to 2 months’ mortgage payment. So, if your proposed mortgage payment, including property taxes, homeowner’s insurance and PMI is, say, $1500/month, then you may need to have that x2, or $3000 in the bank that is not used for closing costs nor down payment. It just ensures you have the money ready to make your first two payments once you do own the home.
How will you know if reserves are required? Let’s talk. It’s just the simplest way. But in general if your credit score is on the lower side, then the likelihood of needing some reserves increase.
Now for the fun one. Most people know their income, and can get a pretty good idea of how much cash they will need to buy the home. Credit scores, on the other hand, cause heartburn.
But that is most certainly not necessary. You see credit scores are just an algorithm that measures how effectively you manage debt. Like any algorithm, one an input changes, the output, or credit score, changes accordingly.
Credit is something to be mindful of if your goal for the year is to buy a home, because in very general terms the higher the credit score, the lower the interest rate…and the lower the cost of PMI as well on Conventional loans.
Although we can say a lot more about credit, for this post let’s keep it simple, and break it down to simple goals and actions that you can take. You will want to:
- Pay credit cards to < 30% of the available credit. So if you have a card with a $3000 limit, work to get that down under $1000 and that will help your score go up.
- Make payments on time. 30- or 60-day late payments really hurt the score, and can harm your ability to qualify for the home loan until several months (6-12 months) of on time payments have been logged.
- Student loans – deferred payments generally make the lender default to counting 1% of the entire balance in your debt ratio. So, if you can put the student loans on a repayment plan, better. Even if the repayment plan is an Income Based Repayment (IBR) plan, that is fine for conventional Fannie Mae loans. A lender just has to see documentation of what the repayment amount is monthly.
- Collections. Medical collections will hurt your score, but are not generally counted as a detriment to qualifying for a home loan otherwise. Any other, non-medical, collection needs to be settled prior to closing on a home loan if it is $1000 or greater. Lesser amounts may, but are generally an underwriter call; and in my experience most that are less than $1000 do not need to be paid prior to closing.
- Co-signing a loan for someone else. Common. And a bad idea. If I had a dime for every time a potential home buyer said ‘Oh, that car payment that is behind on payments is not mine. I co-signed on the car loan for my cousin/brother/daughter/friend.’ Bad news. The car may not be yours; but because you co-signed for it, the debt is 100% yours. If you are in that situation, part of your action plan to reach your goal of buying a home is to get your friend to refinance that auto into their name and out of yours.
- Positive credit. Somewhat common is a potential home buyer who just wasn’t paying attention to credit, but is paying attention now. So, they have some late pays and a few collections. The soon-to-be home buyer now is paying attention and starts to settle the collections and bring other payments current. But, everything on the credit report is or was negative at some point. Also important, then, is to establish new, positive credit.
And that is pretty simple to do. Just open a new credit card, maybe two. But don’t charge much on the new card. Let’s say you open a card with a $300 limit. Never charge more than $20 a month on it; then pay it off in full every month. Rinse & repeat. $20 max every month, then pay off in full. Your credit score will rise dramatically in a short time.
Probably more can be said, for sure.
But this will give you a pretty good action plan to reach your goal of buying a home this year.
Want to get more specific? Let’s talk and set a plan very specific to you to achieve your goal and buy a home. I’ll bet you can accomplish your goal more quickly than you may imagine. It just takes a plan, a roadmap, and some work to make the plan a reality.