Some people who want to buy homes are in a bind these days. Rents in 2018 are going higher and are eating into more of people’s paychecks, and home prices are rising in much of the country. Generally, it is better to buy a home than to rent, as you are building equity as a home owner. As a renter, you are just building equity and paying the mortgage for a landlord.
So you want to get a mortgage, but can you qualify? Things are different than 10 years ago. In the height of the last boom in 2007, there were eight million new mortgages issued. But that number dropped to just 5.7 million three years later as mortgage lenders got burned and lost their shirts. After that, lending standards got much tighter. Even after the recovery, the number of new home loans in 2015 was only 6.2 million.
Why is it harder to get a loan now? After the housing bubble burst, the US government made new rules to ensure that bad mortgages would not tank the world economy again. In some cases, there are many pages of new disclosures that are in loan documents, and heavy penalties for errors made by mortgage companies. So, the tiniest of errors in all that paperwork can be very expensive for the lender.
For instance, if the title insurance policy is $700 but it states $450 in the documents, the lender can have to pay for the difference. Lenders usually sell their loans to Fannie Mae or Freddie Mac, but if there are any errors, the mortgage giants may force lenders to buy back those ‘bad’ loans. All of this means more attention is paid to the paperwork on all mortgage loans today and this raises the cost of issuing a loan. Some in the industry say it takes double the time to do a loan as five years ago. Even with better technology and ‘automatic underwriting,’ all of the paperwork has to be checked very carefully, and income, credit and DTIs carefully checked and rechecked by hand.
Another reason getting a loan is harder is that rates are low. With rates in the low 4s, and even lower two years ago, profits on loans have been less. Lenders costs have gone up and the ability to make a profit has gone down. In this scenario, it is logical for the lender to raise credit standards to ensure maximum profitability on these more difficult loans.
For several years, the average credit score to get a new home loan was in the 700 range. Things have loosened up a good deal in the last two years, but you still need to have decent credit to get a home loan. Expect a score in the low 600s for an FHA loan and at least 640 for a conventional loan.
Another major factor in qualifying for a loan today is proving your income for the past two years. A major problem with loans a decade ago was many were underwritten with ‘no documentation’ and ‘stated income.’ In these loans, there was minimal proof that the buyer had the income that they claimed to have. When the economy tanked, people lost their jobs and did not have the income to pay the mortgage.
Today, you need to show that you have steady, proven income for the past two years before you can get a loan approved. If you have a regular job, you must show several months of bank statements, two years of tax returns, two years of W-2s and pay stubs. If you are self employed, you need a profit and loss statement and two years of tax returns. This can get complicated if you have a high level of tax writeoffs, and are unable to show sufficient income to get a loan.
But it is fair to point out that not everything is gloom and doom. If you have a lower credit score and can document your income, you should be able to qualify for FHA financing with a low down payment as low as 3.5%. As long as you can prove you have the income you say you do, your odds of being approved are quite high. Also, you should show that you have been on time paying your bills for the past year. Past credit problems are not an obstacle to obtaining FHA financing.
You also can increase your odds of being approved by paying down as much debt as you can before you apply. Get your debt to income ratio down and you will have better odds of being approved.
It is true that it is harder to a get a loan now than in 2007. But a lot of it has to do with more paperwork and verifying incomes; if the lender fails to do its due diligence and the loan defaults, the federal government can impose drastic financial penalties.