Rental History, Payment Shock, and Mortgage Applications

First, I just got engaged, and my fiancee and I have been discussing what we want in a house after we get married. It will be the first house for both of us. She spent the last two years living with her parents to pay down her credit card debt.

So she doesn't have a current rental history. Given that she makes more than I do, if we purchase together, my understanding is she will be the primary borrower. Thanks to your site, I've figured out what I can afford without her, and it isn't what we are looking for.

My questions are:

1. Are lenders going to be reluctant to loan to us if she doesn't have a recent rental history? If so, how much time would a lender require.

2. Once we figure out when we are going to be ready to buy, how early is too soon to get a buyer's agent and start looking?

Yes, lenders are more reluctant to lend to you with insufficient rental history. What they are looking for there is a verifiable history of making payments for housing.

Used to be, A paper lenders wanted two years history of making housing payments on time, and might have waived it down to twelve months in some cases. Sub-prime generally wanted the same two years, but it's pretty easy to get it waived down to one year, and occasionally possible to get it way down. Three months in one loan I did about two years ago. All the way down to zero? Probably not.

However, with the general loosening in underwriting requirements, this has largely gone by the wayside. One of my favorite A paper wholesalers just called (on President's Day!), and I asked him about Verification of Rent, and he said "We just don't require it any more unless there's something fishy about the situation." Basically, it's up to the underwriter and whether they make it a requirement for the loan. You can never count on getting it waived, but it's no longer a huge obstacle.

Now, there are potential ways around the requirement, even if they're being a stickler. If your fiancee has been paying rent to her folks, it's likely that the lender will accept canceled checks for six to twelve months as evidence that she has been paying rent. In the case of family situations like this, they want to see real solid evidence of the rent payments being made on time, they want to see that the checks were written and cashed at appropriate times, and they will not, generally speaking, accept a family member's word for it unsupported by paperwork. When you're renting an apartment or something from an unrelated third party, that third party has no particular motivation to paint your situation as being better than it is.

I've seen people advocate this as an application for a stated income loan, where you qualify as a lone individual, but state your income as being enough to qualify for the property and necessary loan that you want. The thinking goes that combined, you make the money, and it's only the fact of some "obnoxious administrative rules" that you can't use her income to qualify. That much is true enough, and that such rules are relaxed now is one thing in their favor. However, it's still lying on a mortgage application (i.e. fraud), and that lender can make life very sticky for you if they should desire to. For one thing, you are de facto using her income to qualify for the loan without giving them a chance to scrutinize her credit record. For another, it's very possible that stating enough income is something the underwriter will challenge (which will happen if you go over the 75th percentile for your occupation), at which point you're not going to get the loan. I wouldn't want to do it without notifying the lender's representative in writing as to what was going on, and it's unlikely that they would approve and fund a loan under such circumstances, but doing otherwise is fraud. I'm sure everyone is all excited by the prospect of doing business with a loan provider who's "only a little bit crooked," right?

Now there is one issue I haven't dealt with that relates to all of this: Payment shock. The idea behind payment shock is that you're used to living on so much money, and people (in the aggregate) strongly tend towards living the same lifestyle over time. Payment shock becomes an issue when your new payments for housing (loan, taxes, insurance, etcetera) are a certain percentage more than you are used to paying for that same thing (rent, in your case). How much more varies from lender to lender and even according to circumstances. For instance, many sub-prime lenders will take into account all of the bills you are paying off in a refinance. Exactly what percentage increase triggers the "payment shock" is lender specific. I've seen it be as low as 25% and as high as fifty. Nor does every lender have payment shock guidelines.

When payment shock is a factor, they are going to require you to have some cash reserves somewhere. Typically, it's two to three months PITI, or principal, interest, taxes and insurance, on your new loan. It generally needs to be in checking, savings, non-restricted investment accounts - some form where you can get to it, not IRAs and 401s, which have restrictions on access. This needs to be left over after your down payment, closing costs, etcetera. So even though you are not making a down payment on the property, you can need to have the money to do so available to you.

Payment shock is one of those things that can make a situation look fishy. If you are trying to avoid payment shock requirements and state that you are paying an amount of rent that is clearly above market rates, they will want to verify it. Can you say, "Out of the frying pan and into the fire?"

Caveat Emptor