Will I Qualify for the Loan to Buy Real Estate During The Market Meltdown?

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With a lot of people running around like Chicken Little screaming about the sky falling, a lot of folks who would like to buy property due to the much-lowered prices are wondering if there is any way they can qualify for the loan. There are lots of people out there over-exaggerating the difficulty of getting a loan. Well, we do have some events in the market that make it harder, but despite the Chicken Littles, the answer to the question is "probably yes." There are some exceptions, and some caveats for those who do, but most people actually can qualify for loans to buy property.

The big caveat is that it may not be a huge beautiful home straight out of the showplace magazine in the best area of town. With the imminent death of stated income and no ratio loans, you have to limit yourself to what you can document the ability to make the payments for. The ultimate sin of stated income was that it allowed unscrupulous real estate agents and lenders to sell people properties which there was no way they were going to be able to afford in the long term. There will be legitimate borrowers hurt, and hurt badly, by its demise, but the aggregate damage done by recurring abuse of stated income was far greater the damage that will be done by its demise. I would like to be able to do stated income, but I can't think of any way to prevent its abuse, and so far, neither has anyone else. Yeah, I may think I'm a good guy, but everyone thinks they're the Good Guys, including those who most emphatically are not. Stated income has been so abused in the last few years that I cannot bring myself to excessively mourn its passing despite the damage said passing will do.

The worst fall out of stated income abuse is all of the foreclosures, but right behind that is the death of the idea in the minds of most of the public that maybe someone who makes minimum wage thirty hours a week might have to settle for a property that might not be as big, as beautiful, and as desirable as the person who makes ten times the national median. If you want to make these folks able to afford the same property, there are only two ways to do it: make all properties equally unattractive, or give the government the power to decide who gets the good stuff, which merely substitutes one privileged group (those with special influence over the government - i.e. the point of a gun) for the current privileged group, who at least earned their money via transactions freely entered into where the other person must have seen some benefit. The guy making minimum wage realistically has two choices: Figure out a way to start earning the same money as the guy making ten times national median, or learn to accept that he can't afford quite as expensive a property, and instead of making with the Green Eyed Monster, be happy with what he can afford. There are ways to improve your property, and improve what you can afford, and I love helping those who will put forth the effort, but it's considerably more involved than waving some metaphorical magic wand. For those who think the prices are going to come down further, they are already headed back up in some ZIP codes. You can sit in denial while they do so, or you can take advantage before it gets worse. I've written before about the best and quickest way to get into something you can't afford right now

Okay, enough with the economics lesson. You're here because you want to know if you'll qualify for a loan now, and probably how much you can qualify for. There are basically three loan programs in the first tier for consideration for most borrowers: conventional A paper, FHA, and VA. I'm going to cover each major criterion: loan to value ratio, credit score, debt to income ratio, in order for each in successive paragraphs, followed by an affordability table.

Conventional

Conventional A paper is the most tightened of the programs, and even here more people can qualify than not, even with the tightened qualification standards. Here's the skinny in the current market: Most conventional loan programs want no more than a 90% loan to value ratio. Turning that around, that means you need a 10% down payment for conventional conforming loans (loan amounts up to $417,000 on single family housing). Temporary conforming ($417,001 to your area's limit) and nonconforming (above your area's limit) have larger down payment requirements. There are ways to get down payments in most circumstances if you want to, but the era of being able to in any wise pretend that real estate is somehow immune from real world consequences - like agents and loan officers who told people "Nothing down! Just sign on the dotted line and walk away if it doesn't work out!" are over - and this is one casualty of the current meltdown that nobody with any sanity will mourn. Real estate is a wonderful investment, properly done, but those jokers weren't doing it right. In order to be doing it correctly, you have to plan ahead for what happens next, and have a plan to deal with it.

Now where A paper lenders were accepting credit scores as low as 620, now they are pretty much wanting to see credit scores of 700 or at least 680, at least for loan to value ratios above 80%. It's not difficult to improve credit score into that range if you will try, but it can take a few months. Your choice: You can make the effort and get it done, or you can miss the best buying opportunity we are likely to see in at least the next ten to fifteen years. Or, you can somehow come up with a higher down payment. Your choice. Lenders have the money; they are entitled to set terms for lending it out. You don't want to meet those terms, you can wait until you have enough to pay cash - and paying all cash for real estate isn't nearly such a good investment.

Conventional loans still want to see the exact same 45% debt to income ratio they always have. There is room for some slop at high credit scores or with certain kinds of income, but if you plan for 45% in the first place, you're still within the loan guidelines they will accept. The way to figure this is easy: take 45 percent of your gross pay. Not what actually hits your account - but what your employer actually pays out. From this number, Subtract your ongoing debt service. That's the maximum you can qualify for. If you want to keep it to less, that's actually a good thing in my opinion, but the general issue is that most folks want to buy a more expensive property than they can really afford. Hence, the stated income debacle. The number of people who can stay strong and within a budget when they're being shown much more beautiful properties "for not very much more on the payment" is relatively small. One reason I keep telling people to shop by purchase price, not payment. If it's outside of your budget, it might as well be on the moon for all of the good it will do you.

This 45% of gross income minus ongoing debt service has to cover all of the ongoing expenses of owning a property. Principal and Interest on the loan, monthly pro-rated property taxes, and homeowner's insurance. If they are present, it also has to pay homeowner's association, temporary assessments such as Mello-Roos, and any other regular recurring expense of owning that property. For instance, assuming a 10% down payment, 6% principal and interest fully amortized loan, California default property taxes, and $100 per month for homeowner's insurance, plus 1% PMI for 90% financing (If they promise there won't be PMI for single loan at 90%, they are lying unless it's VA), here's a table of how much you need to make to afford it (assuming $200/month of other debt):



Amount
$200,000
$225,000
$250,000
$275,000
$300,000
$325,000
$350,000
$375,000
$400,000
$425,000
$450,000
Housing costs
$1,537.52
$1,717.21
$1,896.91
$2,076.60
$2,256.29
$2,435.98
$2,615.67
$2,795.36
$2,975.05
$3,154.74
$3,334.43
Income (monthly)
$3,861.17
$4,260.48
$4,659.79
$5,059.10
$5,458.41
$5,857.73
$6,257.04
$6,656.35
$7,055.66
$7,454.98
$7,854.29

FHA

FHA loans are a federally insured loan program that anyone can theoretically get. FHA loans allow an initial loan to value ratio of 96.5%, so you only need 3.5% for a down payment. On the minus side, they charge a 1.75% funding fee, and PMI-equivalent of either half a percent annualized for loan to value ratios below 95%, or 0.55% annualized for loan to value ratios of 95% or greater. The upshot is that they are not free, but you can borrow up to 98.25% of the purchase price of the property (providing the appraisal supports that value). This is the lowest down payment of any generally available loan currently available.

The enabling regulations for FHA loans still do not require any minimum credit scores, which is all well and good, but the lenders have instituted a requirement for credit scores that vary from 580 to 640 in order for them to be willing to participate. They who have the gold make the rules, and they've had what are euphemistically called "adverse results" with lower scores. You may have read about that. The good news is that it's even easier to improve your credit score to this level than it is to improve to the scores conventional loans require.

Maximum allowable debt to income ratio for FHA loans starts lower, at 43%, but the FHA is willing to issue a waiver up to about 49% pretty easily if you will still have some significant money you can access after the down payment (6 months PITI reserves), or in other words, if the down payment does not represent every penny you have in the world. Nonetheless, if you start and plan for 43% and limit yourself to that, you are better off than if you try to go over. According to what people are most often trying to do with FHA, here is a table of what you can afford with 3.5% down payment, assuming 1.25% (California) property taxes, and the same $100 per month insurance as the previous example, and a base loan rate of 6.25%, as FHA rates are usually but not always slightly higher than conventional. Note that the slightly higher monthly costs are a result of the higher amount borrowed - the cost of money is actually slightly lower under the assumptions given. Once again, I'm assuming $200 per month of other debt; FHA is a lot less forgiving about front end ratio than conventional.



Amount
$200,000
$225,000
$250,000
$275,000
$300,000
$325,000
$350,000
$375,000
$400,000
$425,000
$450,000
Down Payment
$7000
$7875
$8750
$9625
$10,500
$11,375
$12,250
$13,125
$14,000
$14,875
$15,750
Housing costs
$1,608.28
$1,796.82
$1,985.35
$2,173.89
$2,362.42
$2,550.96
$2,739.49
$2,928.03
$3,116.56
$3,305.10
$3,693.63
Income (monthly)
$4,205.30
$4,643.76
$5,082.21
$5,520.66
$5,959.12
$6,397.57
$6,836.02
$7,274.48
$7,712.93
$8,151.38
$8,589.84

VA

The VA loan is a benefit earned by those those who have served in the armed forces. I don't know what the minimum service requirement is, but I do know that they allow a maximum loan to value ratio of 103%. A veteran literally does not have to come up with a down payment. Not only that, but they can include up to 3% of the purchase price into the loan on top of the purchase price. Not one other (non-scam) program I am aware of has ever loaned over 100% of value of the property, and this one is still doing it. Unlike the FHA, the VA only charges a funding fee of half of one percent, and no financing insurance. Furthermore, the funding fee is waived for those with 10% or more service disability. I certainly wouldn't serve in the armed forces just to be eligible for a VA loan, but it is a nice thing that veterans earn for all that they have gone through.

Credit score is as the FHA: none required in the regulations, but the lenders want to see the same basic minimums (580 to 640), and for the same reasons. Once again, credit scores are not fixed and immutable and they can be improved as well as hurt by events. Just because you suffer a blow to your credit does not mean you cannot counter-act it with by making an effort to improve it.

Debt to income ratio is the same as the FHA at 43%, with the same waivers possible for higher. Given the way most folks use VA loans, I am going to use an example of loans for 103% of purchase price, at 6.25% (for the same reasons as FHA), with, once again $200 per month of other debt service assumed. Once again, the reason it is as close as it is to the others here is due to higher loan balances under these assumptions. If you compute the same situation for all three loans, the person with VA eligibility will pay less than either of the others until the loan to value ratio is below 80%, when the conventional loan will be best. Keep in mind that in this case, the VA loan balance is about 14% higher than the conventional, yet the cost of housing is very comparable, and the VA has by far the lowest down payment requirement ($0).



Amount
$200,000
$225,000
$250,000
$275,000
$300,000
$325,000
$350,000
$375,000
$400,000
$425,000
$450,000
Housing costs
$1,576.71
$1,761.30
$1,945.89
$2,130.48
$2,315.07
$2,499.65
$2,684.24
$2,868.83
$3,053.42
$3,238.01
$3,422.60
Income (monthly)
$4,131.89
$4,561.16
$4,990.44
$5,419.71
$5,848.99
$6,278.27
$6,707.54
$7,136.82
$7,566.10
$7,995.37
$8,424.65

Now there are other programs that make it easier to afford real estate, or to come up with the down payment. The Mortgage Credit Certificate and your locally based first time buyer program are a way to increase affordability and possibly come up with a down payment without saving it yourself. The drawbacks to these programs is that their budgets tend to be very limited, and what there is evaporates quickly when they do get an allocation of funds. The three basic loan types are there 365 days per year, and I've never heard of them being unwilling or unable to lend to a buyer who met their qualifications. Providing you meet them, you can get a loan, and therefore, you can buy real estate if this market strikes you, as it does me, as significantly underpriced, given the scarcity and ability of people to pay. Or as Warren Buffet says, "The time to buy is when there is blood in the streets." This principle is no different for real estate than it is for stocks or whole companies. If you can afford to buy with a good sustainable loan, you will be very happy that you did in a very few years.

Caveat Emptor

Article UPDATED here

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This page contains a single entry by Dan Melson published on October 27, 2008 7:00 AM.

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