Twenty years ago, it was common for most home buyers to put down at least 20% on a home. Today, it’s common to put down as little as 4% and some try to put down nothing at all and have the entire price of the home financed. However, these loans are now much harder to come by unless you are a veteran and eligible for the Quicken Loans VA loan. There can be many reasons why someone would want to try and qualify for a no money down home loan. Many times, first time home buyers don’t have 20% saved. Potential home owners could also want to save that money for other things such as improvements to the house or new furniture.

Risks of No Money Down Home Loans

Whether or not you decide to try and qualify for a no money down home loan, there are plusses and minuses that you need to consider. For one, it is much harder after the mortgage lending crisis to qualify for a no money down loan because most lenders see this as a red flag that you will not be able to keep up with the payments. If you don’t have the money upfront, most will assume that you are either bad at saving or don’t bring home enough money making you a lending risk. In fact, a recent study showed that half of the foreclosed homes in Denver came from nothing down loans.

Secondly, keep in mind that the less you put down in the beginning, the more you are going to have to pay in monthly payments. While you might be saving money initially, you will have to have enough to write that check each month.

Next, the less you put down, the smaller your house is likely to be. If you don’t put any money down, banks won’t be as willing to lend as much. This means that you will only be able to afford less of a house. With any size down payment, however, you can typically get a larger house and one you probably want a little more.

In addition, the less you put down, you’ll have to carry Private Mortgage Insurance. This PMI is there to protect the lender against the buyer defaulting on the payments. The lower your down payment, the higher your PMI is going to be. You will also have to continue paying this additional expense until you gain at least 20-22% equity in your home. At this point, it can be canceled and you can put that extra money to other things.

No money down home loans are still available, but you must make sure you can afford the higher monthly payments and the PMI. If you can, and you have near perfect credit in order to qualify, you can save that down payment money and put it toward something else.

In order to get the best online rates, first obtain a copy of your credit report from all three major reporting companies. Check to make sure that there are no mistakes and that all three have virtually the same information. Everyone is entitled to one free report a year and if you find any mistakes, make sure they are fixed immediately.

Be sure to evaluate mortgage points as well as fees. These normally are charged for underwriting a mortgage loan. Don’t be fooled by a great online mortgage quote as the fees and points may make the rate seem too good to be true.

Next, compare the online quotes that you have received once you fill out all the appropriate information online. Compare fixed interest rates against adjustable rates as well as mortgage payments, points, fees, and overall rate. Be sure to get at least three quotes from reputable mortgage brokers.

If you find a mortgage that you believe you would like, be sure and ask for a Good Faith Estimate. This is not a binding document, but it is a written estimate of all the costs associated with originating a loan. This estimate will keep lenders from changing or charging extra fees at a later date.

When looking for an online mortgage, you can go to a traditional lender that also offers loans on its website or you can look for one that specialize in online mortgages such as E-loan or Quicken. Of course, do some research into the company to make sure that they are trustworthy and not a predatory lender and stay clear from any site that seems to promise too much.

Today, most mortgages issued actually come from mortgage brokers. These people are there in order to marry a buyer with specific loan. There are many different services that brokers will undertake including assessing borrower’s credit worthiness, finding a product that matches the client’s needs, gathering the required documentation, completing the lending forms, submitting materials and explaining any legal issues. For their services, many brokers will charge a fee of one to three percent of the loan amount.

As of 2004, there were approximately 53,000 mortgage brokerage companies in the United States. These companies employed almost a half million people and accounted for 68% of all residential loans. In order to keep the mortgage brokerage industry on the up and up, there are more than ten federal laws, five federal agencies and forty-nine state laws or licensing boards keeping an eye on the business.

The most important service provided by a mortgage broker is to act as a go between for the lender and the buyer. As a result, they will work with dozens, if not hundreds, of lenders as a freelance agent. When a buyer comes to a mortgage broker the broker will analyze the client’s credit to see which lender best fits the buyer’s needs. The loan application is then submitted to several lenders and the one that offers the best terms is then chosen. The most talented mortgage brokers can generally find a loan for just about any type of credit or credit history. Once a buyer is presented with the choices for lenders, be sure to shop around and make sure that the terms are reasonable.

As with most things, there are some disadvantages to working with a mortgage broker. At times, a buyer can get overcharged for the broker’s fees and the broker can make false promises of being able to find anyone a reasonable loan. In addition, they may not have access to certain bank programs that a traditional lender would have. Finally, when dealing with out of town lenders, they might not understand local heating or septic systems, thereby slowing down closing until all of their questions have been answered. At these times, using a local bank may be the way to go.

But there are still many advantages as well. A mortgage broker will do all the heavy lifting for you and can look at wholesale rates which will typically be lower. They can also finance tricky deals and may be the best option when trying to finance unique or commercial properties. Mortgage brokers can also be easier to get in touch with and have less levels of bureaucracy.

If you self-employed and looking for a mortgage, the first thing you must do is be very honest with yourself about what you can and cannot afford.  This is especially true if you are dealing with low or no-documentation loans because it can be easy to fudge the numbers a little bit.  You are the only one who truly knows the ebbs and flows of your business and if you can afford the house that you really want.

Once you are certain that you can make the payments, there are numerous things the self-employed can do to make themselves more attractive to lenders.  First, you will want your credit score to be the highest it can possibly be.  Be sure to get a free credit report and check for any inconsistencies or mistakes and have them corrected immediately.  Those with a score over 730 have a better chance of getting a much lower rate, thereby saving themselves thousands of dollars over the course of the loan.

Secondly, put down as much as you can safely afford to do so.  This will make you much more attractive to a lender and you will be less likely to walk away from a home with more money invested into it.  Next, have some significant savings in the bank.  This will show lenders that even if you do fall on hard times, you will have plenty of money to pull from in order to keep up with the payments.  In addition, you will want to pay off any consumer debts such as credit cards.  This will not only free up money for positive cash flow, but it will make it easier to qualify for a higher loan amount.

Lastly, have an established track record of self-employment.  Typically, banks and other lenders will want to see at least two years of documentation.

Speaking of documentation, those who are self-employed will find themselves having to present more of it than traditional workers.  Since you won’t have W-2’s to present, you may find yourself having to show at least two years worth of tax returns, profit and loss statements, business credit reports, balance sheets and documentation which shows your income.

It may also be easier to qualify for a loan if your spouse has a traditional job and a W-2 from their employment.  Because you will be sharing the house, this provides peace of mind that there is a steady income in which to fall back on if need be.

Lastly, be sure to find a lender, either via a bank or mortgage broker, who specialized in loans for the self-employed.  Typically, they will know which type of mortgage will work best for your particular situation and know where to look to get the best rates.

What is a Debt-to-Income Ratio?

A debt-to-income ratio represents a percentage of your income that goes toward paying debts.  Think of it as a snapshot of your spending habits.  Calculating your debt-to-income ratio is very easy.  Take a look:

• Monthly Income =  $4,000
• Monthly Debt = $1,000
• Divide $1,000 by $4,000 to get .25
• Your debt-to-income ratio = 25%

What is Included in your Income Number

Let us look in a bit more detail, how we calculated the monthly income number in the above example.

Your debt-to-income ratio is best figured on a monthly basis.  Your biggest source of income will most likely be your salary.  Debt-to-income ratios are based on gross income (that is before taxes and insurance are taken out of your paycheck). To quickly calculate your monthly gross salary, do so with one of two calculations:

• Take your yearly income and divide by 12
• If you get paid biweekly (every other week), take one pay check’s gross pay and multiply it by 2.17

In addition to your monthly paycheck, include:

• Regular income from alimony and child support
• Averages of bonuses, commissions and tips
• Dividends and interest earnings
• Government benefits and assistance
• Income from a side business
• Other miscellaneous income

What is Included in Your Debt Number

Let us take a look at what is included in your monthly debt number:

• Rent or mortgage payment (including property taxes, insurance, private mortgage insurance and association fees)
• Car payment
• Minimum credit card payments (only minimum due; not balances)
• Student loan payment
• Child support and alimony
• Legal judgments
• Other monthly debt obligations

What is Not Included in Your Debt Numbers

• Food bills
• Entertainment expenses
• Utilities
• Clothing
• Informal personal loans

The Results – How to Interpret Your Number

Once you have calculated your debt-to-income ratio, refer to the following to view that snapshot of your spending habits and financial stability:

• 35% or less: a healthy debt load to carry for most people
• 36% – 42%: pay closer attention to your debt before problems arise
• 43% – 49%: take immediate action as financial difficulties may be imminent
• 50% or more: get professional help to aggressively reduce debt

How Mortgage Lenders Use Debt-to-Income Ratios

Mortgage lenders approach the debt-to-income calculation from the other direction.  They strive to offer loans that will keep their customers within a specified debt-to-income ratio range.  Your lender will use two different ratios to analyze your situation; one factors in only your new housing expense and the other uses your existing recurring debt plus your new housing expense.

The first type of ratio is what is known as a front-end ratio.  This is the percentage allowed for housing expenses only.  For conventional loans (we’ll see the limits for other loan types later) the front-end ratio limit is 28%.

From our example above:

• Your monthly income is $4,000
• $4,000 times 28% = $1,120
• The maximum loan the lender should offer is one that converts to $1,120 per month in HOUSING ONLY debt.

So far, your lender has calculated a mortgage payment based on your income and housing debt.  He will now turn his focus toward your other recurring debt.  This can be a game changer.  Your lender wants to make sure you can pay for your new loan and still pay for everything else.  He will calculate what is called your back-end ratio. The back-end ratio is a percentage allowed for housing expense plus your other recurring debt.  In our conventional loan example, a back-end ratio limit is 36%.

• Your monthly income is $4,000
• $4,000 times 36% = $1,440
• The maximum loan the lender should offer is one that converts to $1,440 per month in TOTAL debt.
• If the difference between the back-end and front-end amounts ($1,440 – $1,120) does not cover your other debts, the lender will need to lower the amount he can offer you.

Ratio Limits by Mortgage Type

The front-end and back-end ratio limits differ depending upon the mortgage type.  Conventional loans are defined as any loan that is not backed by the federal government.

• Conventional loans:  front-end ratio of 28 and back-end ratio of 36
• FHA loans: 31 and 43
• VA loans:: 41 and 41
• Jumbo, non-conforming loans: 45 and 55

The Way the Ratios are Written (and are Mistakenly Read)

In this article I have written the ratios as “28 and 36”.  You will see however, the ratio is more commonly expressed as 28/36.  This can be misleading.  These numbers represent the front-end ratio and a back-end ratio.  We are not looking at a fraction or dividing one number into the other. Though because we are talking about ratios, that could be anybody’s first impression.

Other Tips

• Try running your numbers based on net income (after taxes and insurance) to get a better picture of your situation
• Include all of your monthly expenses in your calculation (remember, the lender will only include formal, recurring debt)
• Run your own ratio before you meet with your lender.  Read our article about being a responsible home buyer to see why.

Source: HSH

Read More About Private Mortgage Insurance at Newbuyer.com

A warning from the resource: “You will find consolidating your mortgage will negatively affect your credit report and potentially prevent you from achieving new loans in the near future.”

Source: FinancialWeb

Learn more about mortgage debt consolidation at Newbuyer.com.

Pre-Qualified

The process of getting pre-qualified for a home loan is quite easy.  You can do so in person at a local bank or mortgage lender or better yet, on the phone or via the internet.  The service is usually free of charge.  The lender will ask you for very basic personal and financial information.  Be prepared to provide your:

• address and how long you have lived there
• total income
• total debts
• current assets
• overview of your credit standing

The lender will use this information to estimate what you will likely be able to borrow.  This is an “educated guess” and is simply used to ballpark the price range for your new home.

While this information is very important to you in terms of budgeting for your home, it may or may not impress the seller if you are hoping to use it as bargaining tool.  The sellers are aware that the mortgage lender is not committed to providing you a home loan as a result of running these numbers for you.  The seller will want more.

Additionally, because the lender did not verify your accounts or debts and in most cases did not pull your credit report, the pre-qualification letter will be chock full of disclaimers.  The pre-qualification statement will be subject to:

• a formal mortgage application
• verification of employment
• verification of assets
• overview of debts
• credit rating and score
• additional underwriting guidelines

Pre-Approved

A mortgage pre-approval takes the pre-qualification process a few steps further.  A pre-approval will impress a seller and will give you even more confidence regarding your home buying budget.  And as a bonus, getting financing out of the way will let you focus on picking the right home in the right neighborhood (the fun part of home buying).

A pre-approval requires a formal application process.  Be prepared to provide:

• pay stubs for last 30 days
• two years tax returns and W-2’s or business tax returns
• proof of other income
• proof of other assets (stocks, pension funds)
• three months of bank records for all accounts
• source of your down payment
• contact information for employers for the last 2 years
• contact information for landlords for the last 2 years
• current debt information: account numbers, payment amounts, balances, etc.

Upon approval you will receive a formal pre-approval letter.  This will be a written commitment from your lender which your sellers will be thrilled to see.  Be aware however, it is not free of conditions, yet.

When the lender pre-approved you, it was only for the amount of money which you can afford for the purchase of your home.  Remember, you have not yet found that home.  When you do, the lender will insist on an appraisal of the property so they can be sure they are not lending you more money than the house is worth.

Additionally, if there is a significant amount of time between your pre-approval and when you find your home, the lender will want to make sure there are no changes in your employment status, financial situation, or credit worthiness.  When you are ready to close on the loan, the lender will re-verify your information.

Your mortgage loan will be fully approved when the appraisal is complete, the title search is done, your information is re-verified and a credit-check is re-run.