What do mortgage lenders look for when they scrutinize your finances? It all boils down to financial stability and making sure you’re a good credit risk.
On your application, you’ll be asked to disclose personal finance information that will help the lender decide whether your finances are stable or precarious at that moment in time.
Salary/Annual Income: Lenders want to see that you’re gainfully employed. If you’re employed as a full-time employee, receiving a W2, that’s going to be the best indication of financial stability. (Lenders don’t assume you’re going to be losing that job anytime soon.) If you’re a 1099, or contract employee, or if you own your own business, you can still buy a home or refinance, but you’re going to have a tougher time proving that you’re financially stable. Lenders see 1099 contract employees as temporary, even if you’ve been “temporarily” employed for years in this manner. Self-employed individuals (and those who receive 1099s) will have to show stable income for at least two to three years, which is usually done through tax returns.
Tax Returns: Your lender may ask you to provide copies of your tax return (particularly if you own your own business), but you’ll be asked to sign a tax form permitting the lender to pull its own copies of your tax return directly from the IRS. Obviously, with today’s tax software, it’s easy to create a second set of tax returns you didn’t file with the IRS. This way, your lender can see what’s really going on with your finances. Tax returns can be a minefield with today’s lenders.
Bank/Retirement Account Statements: Lenders want to see how much cash you have on hand, and how cash has come into and out of your account over the past year (and sometimes longer, particularly if you’re a small business owner or a 1099 contract employee). Large, unexplained cash withdrawals and deposits are a red flag, as are accounts with extremely low balances. If you’ve overdrawn your account – watch out. Lenders really don’t want to see any sign that you’re not managing your financial accounts with the utmost of ease.
Cash on Hand: How much cash you have on hand is a bigger issue for lenders now than in the past. You’ll need cash to pay closing costs, and to have in reserve. Lenders want to see at least a month’s worth of expenses (mortgage payment, taxes, insurance) to make them feel as though you won’t go delinquent on the loan payment at the first sign of trouble.
Credit History/Score: Since Minneapolis-based Fair Isaacs invented the concept of a credit score, it’s been one of the key factors lenders consider when deciding whether to approve your loan application. That hasn’t changed. In fact, lenders are now looking for higher credit scores than ever before. Managing your credit history is a skill that’s becoming increasingly important, as we move to an electronic society. You need to regularly check your credit history, and if there are errors or your history contains erroneous information, you’ll need to work on correcting those problems. You’ll also need to think about how each credit account you open or close, and how you use the lines of credit that you have, will affect your credit history and ultimately your credit score. Having a higher credit score will save you thousands of dollars over the life of any loan you take out.
You can get a free copy of your credit history and pay for your credit score (around $9) at AnnualCreditReport.com. This is the site maintained by the three credit reporting bureaus: Equifax, TransUnion, and Experian. You can also buy a copy of your credit score from each credit reporting bureau and directly at MyFico.com.
Homeowners looking to lower their monthly mortgage payments and also save some on interest may be able to do so without all the hefty fees and daunting credit requirements of refinancing.
A little-known strategy, called “recasting,” or “re-amortization,” is available through some mortgage lenders and servicers.
It involves paying off a lump sum of the principal amount and asking to have the monthly payments reset according to the original interest rate and loan terms. The lump sum reduces the principal, so your new monthly payments decrease slightly and you save on interest paid over the life of the loan.
Lenders typically charge an administrative fee of $150 or more for this service, though borrowers are not required to pay closing costs or submit to another credit check, because they are not asking for a new loan.
Recasting works well for those unable to qualify for refinancing amid the ever-toughening credit guidelines — perhaps because they are self-employed or have less-than-stellar credit — as well as for those with extra cash, like a year-end bonus.
Making extra payments toward the principal while not asking the bank to recast a loan keeps monthly payments the same and merely shortens the time it takes to pay off the loan.
Lenders, which would probably rather earn thousands of dollars in closing fees from refinancing your loan, are not obliged to recast mortgages. And certain types of mortgages, for example interest-only and adjustable-rate loans, usually aren’t eligible. The borrower will also need to have been current with all mortgage payments to qualify.
While few if any lenders advertise recasting, “they are trying to become more customer-service-oriented, and they will do it on a case-by-case basis.
As with anything that involves your finances or your mortgage, you are strongly encouraged to talk with a financial advisor or CPA before making any changes in your current situation, especially when your home could be at stake.