As underwriting guidelines
for lenders become more stringent, we need to re-examine what a good mortgage
application looks like. As home buyers begin their search for a home, there are
a few items they should be aware of that they can do to help get their loans
approved (with the best possible terms), and, at the same time, lessen some of
the stress that goes along with the mortgage process.

1. Income documents

Most lenders want to see a
full month of paystubs and two years’ complete Federal Tax Returns. Assembling
them ahead of time and holding on to every paystub you get is a good idea even
before you find a home and/or submit your mortgage application because it will
save you time later. Moreover, looking at those documents and being prepared to
explain any deductions that show up is crucial. Child support, alimony, garnishments,
and Unreimbursed Employee Expenses are often crippling factors that, if
explained and dealt with upfront, can make your loan approval smoother.

2. Asset documents

Most lenders will scour
your bank accounts for the two months prior to going to contract. They are
looking for large deposits because large deposits can signal a new loan that
wouldn’t show up on your credit report yet. What’s a “large deposit”?
Typically, any deposit that would represent more than your income can support.
If you make $5000 a month, after taxes you likely net $3800 (or $1900 a
bi-weekly pay period). Therefore, deposits in excess of that will need to be
explained and documented. Sold a motorcycle? Have a paid receipt and motor
vehicle documents in place. Received a gift? You will need a Gift
Affidavit, proof of the donor’s ability and transfer of the funds. Any and all
questions should be discussed with your loan officer.

3. Credit Score Optimization

Do your best to curtail
your use of credit as it relates to your available credit lines. Target a cap
of 30% of usage of available lines to get the best scores. Do NOT cancel credit
cards. That will lower your amount of available credit, thereby raising your
percentage of usage. That will damage your score. Do NOT shop for a car,
explore life insurance, apply for a new credit card or increase the limits on
your current cards because the running of your credit by people in other
industries will also lower your credit score. Most importantly, don’t do
anything that will require having your credit run without first discussing it
with a mortgage professional who knows the impact it could have.

4. Appraisal Concerns

It’s unlikely you will make
an offer to purchase without checking out comparable home sales. It’s also
likely you received that type of data from the real estate agent you are
working with. Make sure your agent prepares the same information for the
appraiser. Data about similar sales, similar homes currently on the market and
maybe even cost estimates for any repairs or improvements anticipated can
preempt future problems with appraised values and conditions.

Overall, it is recommended
that you hold onto copies of everything financial, think before allowing your
credit to be run and work with an agent and loan officer who can use their
experience to put your loan application in its best possible light…as soon as
you start thinking about buying a home.

When lenders evaluate mortgage borrowers, they look at four things: income (the ability to repay), credit (the
willingness to repay), collateral (appraised value and property condition) and assets (cash in the deal and cash
reserves after closing, mostly). Of the “four legs of the table”, assets are the least discussed, and yet may be the most important.

What do we mean when we talk about assets?

• Monies
  needed for the down payment (the difference between the
  purchase price and the loan amount which may or may not be the same as the
  money deposit at contract signing)
• Monies
  needed for closing costs (fees to the lender and third
  parties for things like appraisals, title insurance, settlement services,
  and so on)
• Monies
  needed for Pre-Paids (homeowners insurance, flood
  insurance, real estate taxes, etc.) and establishing escrow accounts for
  future payments
• Monies
  for Reserves- the money you still have left
  after closing. Monies that would be available, if a problem were to arise

Why do we care about assets?

• Assets
  may be the truest reflection of a borrower’s fiscal strength. Their
  ability to save and properly budget could be a significant indicator to
  their future paying habits
• The
  source of the assets is important. Savings? Gift or inheritance? Lottery
  victory? Insurance settlement? Sale of a baseball card collection? Each
  reflects differently on the borrower.
• Many
  people don’t show all their income on their tax returns (it’s just a
  fact). Undocumented income can’t be used to qualify; however, often assets
  become a truer representation of a borrower ability to pay than their
  1040s.
• Reserves
  are an issue. A client with $50 in the bank after closing is riskier than
  one with $50,000. Also, clients who have money in the bank but have some
  sporadic lates on their credit are looked at differently than those who
  didn’t have the money to make the payments.

Common Asset Issues in Mortgage Packages:

• Large
  deposits (defined as those which are
  excessive for the income level) raise an underwriter’s eyebrows. Where did
  the money come from? Maybe the borrower took a loan that doesn’t yet show
  up on their credit report.
• Cash
  deposits are another red flag. In this
  day and age, people keep their money in the bank, not under their
  mattress. Where did the cash come from?
• Gift
  monies and seller’s concessions, while
  considered as borrowers assets when doing calculations, will give an
  underwriter pause when assessing the borrower’s real ability to replay.

Guidelines have tightened.
When borrowers are paying off credit cards to get their ratios in line, lenders
are asking where that money came from now. That act has nothing to do with the
home purchase, but may be a sign of something fragile in the borrower’s
financial make up.

The best advice is to consult a loan professional to discuss the proper way to position your assets
and the timing of it that will put you in the most favorable light.

We read an interesting
article in the Wall Street
Journal on Monday titled A Home Is a Lousy Investment. It was written by Mr. Bridges, a professor of
clinical finance and business economics at the University of Southern California’s Marshall School of Business. The essence of the piece is that owning a home is not a
good financial investment for younger generations. The subtitle:

“Today’s young people
would be foolish to imitate their parents and view ownership as the cornerstone
of personal finance.”

Today, we would like to
counter some of the points made by Professor Bridges. The professor looks back
on California home values over the last thirty years and begins with the
assumption:

“If a disciplined
investor who might have considered purchasing that median-price house in 1980
had opted instead to invest the 20% down payment of $19,910 and the normal
homeownership expenses (above the cost of renting) over the years…

There are several
challenges with these givens. Let’s break them down.

“a disciplined investor”

There
is no doubt that discipline in savings is important. However, studies show that
homeowners attain greater wealth because of ‘forced’ savings.

The Joint Center for
Housing Studies at Harvard
University released a study, America’s Rental Housing: Meeting Challenges, Building on
Opportunities. They explain:

“In addition, renters
have only a fraction of the net wealth of owners. Near the peak of the housing
bubble in 2007, the median net wealth of homeowners was $234,600—about 46 times
the $5,100 median for renters. Even if homeowner wealth fell back to 1995
levels, it would still be 27.5 times the median for renters.”

“invest the 20% down payment”

The professor’s math
supposes a 20% down payment. What about the people who put 5% down or 10% down.
What about those who purchased a home with an FHA mortgage putting 3% down; or
our veterans who used a VA mortgage to purchase a home with no down
payment?  (For
those who think low down payments have caused the current foreclosure challenge,
the difference in default rate between a 5% down deal and a 20% down deal is
less than 1%).

“normal homeownership expenses (above the cost of renting)”

It’s great that Professor
Bridges looked at data over the last 30 years. History is important. Foresight
is much more valuable than hindsight however. In most parts of the country,
homeownership is currently less expensive than renting. There is not MORE money
to invest if you rent. There is LESS.

In their report mentioned above, Harvard
University found:

“Rental markets are now
tightening, with vacancy rates falling and rents climbing. With little new
supply of multifamily units in the pipeline, rents could rise sharply as demand
increases.”

Trulia, in its second quarter 2011
Rent vs. Buy Index, stated that buying a home has become more affordable
than renting in nearly four out of five (78%) major cities. Ken Shuman, Head of
Communications at Trulia
said:

 “With home prices
nearing a double dip and more foreclosures expected to flood the housing market
over the next two years, the decision between renting and buying a home across
most of the country has clearly moved in favor of buying.”

The premise of Professor
Bridges article doesn’t apply to the current market. Even some in the academic
world agree that now is the time to buy.

Business School professors
Eli Beracha of East
Carolina University and Ken H. Johnson Ph.D. of Florida International University
have done extensive research on which makes more sense financially: to rent or
own a home. They published a sensational paper on this issue: Lessons from Over 30 Years of Buy versus Rent Decisions: Is the
American Dream Always Wise?. In their paper, they explain:

“[F]undamental drivers
now appear to be in place that favor homeownership over renting in the near
term future…

[This] finding might
seem unwise to many given the recent crash in the real estate markets around
the country. However, rent-to-price ratios now seem to be in place along with
other fundamental drivers that favor ownership over renting.”

They conclude their
research paper with this sentence:

“Conditions
(historically low mortgage rates and relatively low rent-to-price ratios) now
seem in place to favor future purchases.”

If Professor Bridges’ assumptions are incorrect,
how much value can the conclusions hold?

Bottom Line

The best advice given in
the Wall Street Journal
article was in the last paragraph:

“Owner-occupied homes
will always be the basis for healthy and stable neighborhoods.”

And, in today’s
market, a home is also a fabulous investment!!