People don’t just set out to apply for a mortgage loan with the intention of getting denied. Yet it happens.
While there are some loan officers that will give out Pre-Qualification letters without properly verifying information, some problems can simply take a while to uncover. The best way to avoid surprises is to go through a full lender underwrite, and obtain a Pre-Approval – but even that’s not guaranteed if a borrower delays or omits to submit all the requested documents.
This blog post is for my fellow real estate agents that are often frustrated with the mortgage lender over the denial.
This blog post is also for those creditworthy borrowers that make the incorrect assumption that mortgage guidelines follow common sense. In some respects they do, but in a lot of cases they couldn’t be further apart.
Last but not least, this blog post is for those of you that want a roadmap to a smooth mortgage loan application.
Here are 7 major issues I’ve had to deal with as a mortgage loan officer, and that were not always evident in the beginning of the loan.
1. Undisclosed debt.
Your credit report will have a pretty accurate picture of your financial situation regarding liabilities (debt). But some debts don’t necessarily report on there. I’m talking about Federal and State Taxes, Child Support/Alimony and Personal/Signature Loans.
Federal or State owed taxes will either show up as a lien, or be discovered when the lender pulls your tax transcripts (you sign a 4506-T form with every mortgage application).
Why does this matter? Taxes do not follow lien priority rules, they get paid first – before the lender, and before any other creditors. Whether you’re dead or alive. If significant enough, taxes can even push a home into foreclosure – the F word that all lenders absolutely hate.
So if you owe back taxes, you need to either pay them in full, or setup an installment plan. If you do an installment plan, then you’ll need to wait a couple of months so you can prove good faith in your intent to repay. You can contact both the IRS or Utah State Tax Commission to start your installment plan asap. Please note that the monthly plan payment will be included in your debt to income ratios for mortgage qualification purposes. So you might want to keep it on the low end, even if you’re planning on potentially making larger payments and tackling that tax debt faster.
Child Support missed payments will often be reflected on your credit report. If you’ve been paying on time, but simply fail to disclose it (or actively try to hide it), an underwriter will uncover it by either asking for your divorce papers, or by analyzing your bank statement transactions.
The trickiest situations are the ones where one parent initially had custody, but then the children ended up living with and being supported by the other parent. This needs to be addressed legally, because child support payments don’t just automatically stop, regardless of the existence of a friendly mutual agreement. The designated party is still legally responsible to pay them, even if the other parent is no longer enforcing the requirement. Either make sure you qualify with the child support payment, or take the legal steps to properly terminate the legalities involved.
Personal or Signature Loans are loans that do not require a credit check. It’s usually an easier way for people with not so great credit to buy overpriced appliances or mattresses. These loans won’t show up on your credit report, but the recurring payments from your bank account will give you away every single time.
2. Overdraft Fees or Non-Sufficient funds (NFS)
Non-sufficient funds show up when your bank declines a payment because you have no money available in your account to cover the charge.
Overdraft fees happen when you sign up for overdraft protection. Your bank will allow a payment go through even if your checking balance goes into negative – but will charge you a fee to do it (usually $25 or so per each authorized transaction).
Between the two, overdraft fees are a little better looked at, but not if they’re excessive. If you use your overdraft protection constantly because the money is tight, you might want to reconsider your ability to afford a mortgage payment. It’s a big red flag for a lender.
The presence of either fees on a bank statement can cause a denial on a lower credit score, or lower down payment loan. It generally points to financial instability, or even financial disregard.
If you have overdraft or NFS fees on your bank statements, be prepared to have a solid explanation on why they happened, and why they are unlikely to ever happen again. Be aware that your bank statements will reflect not only the fees from the specific month, but the year to date charges.
3. Large Employment Gaps
Be prepared to document 2 years of employment history – unless you can show you’ve recently attended school, or performed some sort of internship that will help your future earning prospects.
Maybe you were lucky enough to be able to take a year off work and go backpacking through South and Central America ( I had such a borrower). Maybe you had a child and did the stay-at-home Mom for a while. Whatever your reason, make sure you’re on your current job for at least 6 months, and that you can document a 2 year work history prior to your employment gap.
Another tricky situation is if you are an immigrant adjusting his or her status, and you were unable to legally work until you were issued a work permit. Please contact me at [email protected] if that is the case, because common sense and mortgage guidelines don’t always go together. You’ll need additional documentation from your home country.
4. Changing the business entity when self employed
Lenders like income stability. If you’ve ever been self employed, you know that your actual business, and the way you file taxes can be totally different.
A lot of self employed people actually get 1099 forms from the company they work for, but that doesn’t recognize them as employees. Instead, they are considered contracted individuals, available only when needed. This means that the respective company doesn’t have to pay benefits, overtime or employment taxes on their behalf. In return, the contracted individual is treated like a business, meaning he/she gets to deduct a bunch of expenses, and potentially pay a lot less in taxes.
It seems like a win-win situation – until someone has to apply for a mortgage.
Contracted individuals report their self employment income in various ways. The easiest way to do it is on Schedule C of the tax return – either as a sole proprietor, partner, or an LLC. When the self employment is high enough, the tax liabilities can be higher is using a Schedule C. Many CPAs will recommend that their self employed clients use an S-Corporation instead.
If you’re self employed and you close your 3 year old LLC to start a new S-Corp for the purpose of saving on taxes, expect to run into trouble when applying for a mortgage. This is because in the lender’s eyes, you just opened a new business, one with no track record of making a profit.
This is not the end of the world, and if your 1099 income is still from the same source, you can make a case to consider it stable. But lenders that are risk averse can flat out deny your loan. And those are generally the lenders that offer the lowest interest rates.
Not all loan officers understand self employment, so make sure you’re working with someone that does, and can build a case for you and your business.
Be mindful when filing your taxes, because only your net income will be used to qualify you. Gross income is irrelevant when self-employed.
5. Too much or too little income
This becomes an issue when overtime, bonuses or commission income are involved.
These income types can be problematic when qualifying for a loan that imposes income limitations, such as the USDA Rural loan, or applying for down payment assistance. It’s important to realize that your income will be looked at from 2 different perspectives:
- USDA or the down payment assistance will use “projected” income to make sure you don’t make more than their guidelines allow. If you receive a significant bonus at the end of each year and you have a 2 year history of receiving it – it doesn’t mean you can apply for a loan in the summertime, and pretend the extra income won’t be received. Your “projected” bonus will be divided by 12 months and added to your “projected” income, potentially causing a loan denial due to exceeding the income limitations.
- An underwriter might look at the same bonus income and refuse to let you use it for qualification purposes if there is indication that it is significantly decreasing, or unlikely to continue.
In short, the income used to qualify you for a mortgage can be different that the income used to make sure you meet guideline limits. It sounds insane, but there is such a thing as too much and too little income at the same time, and a careful analysis is necessary. Verifications of employment are the best way to check these things, and they have to be requested directly from your employer by your loan officer.
6. Increasing debt before closing
Please don’t go out and buy a new car before your loan funds. Or open a credit card and charge a bunch of new furniture to it.
Lenders monitor your credit report for new debt and new credit inquiries before funding on your new mortgage loan. This is mostly to insure you don’t get 2 mortgage loans on the same property, but it will also catch and flag shopping sprees. Save us both the headaches and stay put until the loan is completely finalized and your name is on title.
7. Quitting a job or getting fired
The lender is extending credit to you based on your income, and a solid possibility that this income is likely to continue. If your income source is discontinued before your new mortgage loan closes, the lender will need to reassess if you can afford the payments. Any approval you might have received can be reversed.
What to do if your loan approval is threatened by any of the above?
I like to think that there is a solution for every problem, but time is of the essence. Getting important documents from my borrowers can sometimes feel like pulling teeth.
For the sake of everyone’s sanity, including your own – please prioritize your loan documentation so any potential issues are uncovered and tackled ahead of time. Your earnest money will stay protected, and you won’t end up paying for a home inspection and/or appraisal on a denied mortgage loan.
Be honest about everything with your loan officer, and brainstorm for ideas together. And if you don’t feel like they’re helpful or understanding of your situation, ask for a second opinion. Your loan officer is your best and only advocate you have, so make sure they’re on your side and are willing to put in the effort to see your loan approved.
Questions are always welcomed in my inbox at [email protected].