Why Cash-Out Refinancing May Not Always Make Sense

Posted by Jeremy Bachmann

Apr 24, 2014 9:00:40 AM

Image by Images Money. Licensed under Creative Commons.

If your home value is now comfortably above water, you may be tempted to refinance once again to  take cash out from your improved  home equity.  Cash-out refinances typically have no restrictions on how you use the cash you receive.  The proceeds can go towards anything from making home improvements to paying for a child’s education or even a new car.  

Such loans were popular before the economic downturn, but practically disappeared after home values fell and guidelines tightened.  Home values have risen in many regions of the country, however, and this increase in home equity has led to the resurgence of cash-out refinancing among some lenders.  

While lenders may be willing to loosen their purse strings based on improving economic conditions – should you be willing to loosen yours?  Maybe.  But, there are multiple financial consequences that you should carefully weigh before making this important financial decision.  

First and foremost is comparing your current mortgage rate to the new cash-out refinance interest rate. According to a recent FHA Housing Study; 54% of responders have refinanced in the last 2 to 3 years, representing millions of US homeowners.  If you’re one of these smart consumers, you likely have a historically low fixed rate in the 3 to 4 percent range.  This rate is definitely worth protecting.  

The following are additional important factors to consider before proceeding:  

  • Mortgage rates are up.  It bears repeating -- don’t give up your historically low rate too easily for today’s higher rates unless it makes financial sense from a cost return perspective.
  • You could be increasing lifetime interest costs substantially.  Cash-out refinancing restarts the amortization process.  You're now paying the higher interest rate on the full new balance, not just on the newly borrowed cash.  This also means that your monthly payment resets to mostly paying interest and not reducing the principal balance.
  • You’ll have to recoup the fees and points you pay to originate the loan.  You’ll likely pay points on your new loan or pay a higher interest rate to avoid them.  That, plus standard loan fees, means you’re paying thousands of dollars in fees just to borrow the cash.  And of course the smaller your cash-out balance is, the less attractive your return on costs is.
  • Is it worth it?  This is a question only you can answer.  Take a close look at the total costs (see our example below) and weigh it against how you plan to use the funds.  Are you making improvements to your home or paying a college tuition? Or are you using the money to take a vacation or pay credit card bills? Some uses make more fiscal sense than others. You may have the immediate gratification of cash in hand, but you could be paying dearly for it.  Many borrowers who use their home equity to pay down credit card debt end up back in debt within a few years.
  • Get a second opinion.  Some lenders are more consultative than others.  It’s always worthwhile to speak with more than one lender when considering your options.    

A Cash-Out Refinancing Example

Our borrower, James,  last refinanced his house in December 2012 for 3.25%. He’s now thinking about refinancing and taking $25,000 in cash to make some improvements around the house.    

In the scenario below, James will pay an extra $136 a month, $4525 in points and fees, and over $44,000 in lifetime interest for the $25,000 cash he receives today.

  Current Loan Cash-Out Refinance
Original Loan Amount $200,000 $204,525
Cash Out   $25,000
Current Loan Balance $175,000 $175,000
Home Value $325,000 $325,000
Current Monthly Payment $870 $1,006
Current Interest Rate 3.250% 4.250%
Loan Start Date 12/2012 4/2014
Loan Pay Off Date 11/2042 5/2044


Points   $2,025

Interest Expense

$113,349 $157,685
Additional Lifetime Interest   $44,337


Ordinarily, borrowers refinance to obtain better loan terms – a lower interest rate, a shorter term, or a predictable monthly payment when switching from an ARM to a fixed-rate loan.  By refinancing out of your existing low interest rate, you’re increasing the amount and term of your mortgage, while raising the interest rate and monthly payment.  There are some situations where taking cash out of your home equity is wise or even necessary, but you should weigh all the factors before moving forward.

If you must have funds, keeping your existing mortgage and borrowing with a home equity loan or line of credit can be the less-expensive option.  You'll preserve your existing low first mortgage rate and typically have lower closing costs.  Talk to your current lender, who can help you compare your options and determine the best fit for your financial situation.


Topics: refinance

Understanding the Rules for Deducting Home Mortgage Interest

Posted by Jordan Blakley

Apr 15, 2014 2:11:38 PM

6925356314_e790cdf4bf_mThe IRS's home mortgage interest deduction is one of the most valuable tax write-offs for American families. While its effect can vary depending on your income, other deductions, and your mortgage, it's likely that it will reduce your annual tax costs by thousands of dollars. Claiming it is relatively simple for most people, as long as you follow the IRS's rules.

1) Itemize or Else

To claim the deduction, you have to itemize by filing a long-form 1040 tax return and attaching Schedule A. This means that you have to give up the standard deduction, which is $6,200 for a single person or $12,400 for a married couple as of the 2014 tax year.

However, when you itemize your deductions, you get to write off more than just your home mortgage interest. The IRS also lets you deduct your state income tax, property tax, charitable contributions and a bunch of other items. As long as they add up to more than your standard deduction, you come out ahead itemizing.

2) Which House? Which Loan?

The IRS doesn't let you write off interest on just any loan, though. First, the loan has to be a mortgage, which means that it needs to have your home as collateral. Putting a home improvement on a credit card doesn't make the interest deductible. It's the type of loan that matters.

Second, the mortgage has to be taken out against your first or second home. For the IRS's purposes, a house is anything that you own that has a sleeping area, a kitchen or a bathroom. We tend to think of houses and condos, but the definition could include boats and RVs, too.  If you own more than two houses or other qualifying items, though, the mortgages against those additional pieces of property aren't deductible (unless they were used for business, investment, or some other deductible expense).

A second home isn't the same thing as a rental property, however. If you rent out your second home, you have to live in it at least 14 days during the year or 10% of the number of days you rented out the home.

3) Loan Limits

The IRS applies two different limits to the home mortgage interest deduction. Interestingly, they aren't tied to how much interest you pay, though. Instead, they're tied to how much you borrow.

You can deduct up the interest on up to $1 million of what the IRS calls home purchase debt. This category includes money that you borrow to buy a house. It also includes money that you borrow as a part of a refinance. A loan that pays for repairs to your house, renovations, or remodeling is also considered home purchase debt. Generally, if the money goes back into your house, it's purchase debt.

In addition to that write off, you can also deduct the interest on up to $100,000 of home equity debt. Home equity debt is money that you borrow against your house for any purpose other than to buy, build or repair it. Debt consolidation loans or cash that you take out in a refinance are examples of home equity debt. You can also use home equity debt as home purchase debt, giving you an extra $100,000 of cushion.

4) Elimination of the Deduction for Some

Two tax rules wipe out or reduce some taxpayers' home mortgage interest deductions:

  1. The Alternative Minimum Tax eliminates most deductions and replaces them with special tax rates and a special large AMT exemption. It leaves your deduction for your mortgage interest, but eliminates the deduction for home equity debt interest.
  2. The "Pease Limitation" gradually reduces the value of most itemized deductions for high income taxpayers that aren't subject to the AMT. It reduces the value of all of your mortgage interest deductions -- home purchase and home equity debt.

These limitations typically only apply to families with significant incomes. If you aren't making over $100,000 per year, it's relatively unlikely that the AMT will affect you, and the Pease Limitation only comes into play with incomes that are over $250,000.

There are many special situations that affect some homeowners' mortgage interest deduction. Late payment charges, prepayment penalties, home sales, divorce - even minister and military housing allowance can impact your deduction.  Tax laws and regulations change all the time and how they impact you depends on your own financial situation. If you've got questions about how mortgage interest deductions affect you, consult your professional tax advisor.


Understanding ARMs - The Basics of How ARMs Work

Posted by Jordan Blakley

Apr 3, 2014 4:38:30 PM


An adjustable rate mortgage (ARM) is most simply defined as a home loan with an interest rate that can go up or down over time. Part of the rate is typically based on a broader measure of interest rates, called an index. Like any other loan, the initial agreement spells out the terms, so you should have a clear understanding of all the details before you make a decision.

Some of the factors you should consider when evaluating an ARM include the initial rate, the initial rate period, and the adjustment period.

We'll use the example of a lender offering a customer a "5/1 LIBOR ARM at 3.25% with 2/2/5 caps."

What is the Initial Rate and Period?

The interest rate that you secure when you first get an adjustable rate mortgage is the initial rate. In many cases today, the lender may offer a fixed rate for a period before the adjustment period begins. PennyMac, for example, offers adjustable rate loans with 3, 5, 7, and 10 years of an initial fixed rate. This type of hybrid ARM offers a period of predictability for the initial period, making it a desirable option for certain types of home buyers.

Example: In our example, the initial rate on the loan is 3.250% for the first five years. 

What is the Adjustment Period?

The adjustment period is the length of time that your interest rate will remain unchanged, once the initial period is over. For example, an ARM that specifies a recalculation of your mortgage interest rate at the end of each year has an adjustment period of one year. During this time, your interest rate will remain the same, but it may change from year to year depending on variations in the market index.

Example: In our example, after five years the interest rate can adjust once a year (the 1 in the 5/1).

How are Adjustments Made?

Although the specific details vary depending on the lender and your loan terms, interest rate adjustments often reflect the changes in the market index your loan uses. Many loans today are based on the London Interbank Offered Rate (LIBOR). If the market index increases, your interest rate will also likely increase. On the other hand, if the market changes favorably, your rate might decrease accordingly.

Example: In our example, the annual rate adjustment in our example loan is based changes in the common (LIBOR) index.

Are Interest Rates Capped?

Many ARMs specify the maximum amount of each adjustment and on how high your interest rate can go over the life of the loan. In our example, the 5/1 ARM has 2/2/5 caps. This means that at the first adjustment, the interest rate cannot go up or down more than 2%. The second 2 represents every adjustment after the first one. From the second adjustment to the end of the loan, the annual adjustment can't go up or down more than 2%. The last digit in the caps, the 5, represents the lifetime ceiling adjustment.

Example: In our example, the interest rate can never go higher than 5% above the initial rate (3.25% + 5% = 8.25%)

When Should You Consider an ARM?

Because of the unpredictable nature of ARMs compared to a fixed-rate mortgage, you should prepare for a higher interest rate in the future. However, the initial rate for an ARM is often relatively low, so this type of loan can be a good fit in the following cases:

  • Brief period of ownership - If you plan to buy a home and resell it relatively quickly, you can take advantage of the lower initial rate. This also applies if you plan a mortgage refinance. In our example loan, a buyer planning on staying in the home five years or less may worry less about the adjustment period since they don't plan to own the home at the time of adjustment.
  • Steady income increase - If your career trajectory is likely to include a steady or predictable increase in income, you can plan for potentially higher rates in the future.
  • Long-term plan for rate increase - Even if you can already afford a higher initial rate now, an ARM allows you to save during the initial rate period so you can apply those savings in other ways.  In our example, if the borrower is able to afford the monthly payment at 8.25%, they can enjoy the monthly payment savings from the lower initial rate, putting the money to other uses.
  • Risk tolerance - If you believe that the market is likely to shift in favor of lower interest rates, an ARM is a good choice, but only if you are able to pay the full interest rate

If you are considering an ARM or would like to learn more, the Federal Reserve has provided the Consumer Handbook on Adjustable Rate Mortgages (ARM) as a reference tool that includes a checklist to help you compare mortgages.

Do you have experience with adjustable rate mortgages? Tell us about it in the comments section below.



Topics: mortgage process

Tax Time - Deducting the Expenses of Owning a Home

Posted by Jordan Blakley

Mar 31, 2014 4:40:06 PM

6757824757_f607201a27_zAccording to a 2009 paper from the National Association of Home Builders, a relatively typical American household taking out a typical mortgage can save around $8,600 on taxes in the first five years of homeownership. While you might know that you can write off your mortgage interest, this deduction is one of many that you may be eligible to claim. While laws vary and your situation may be different, here are some of the many expenses that might be deductible for your home.

Mortgage Interest (Including Refis, Seconds and HELOCs)

The IRS lets you write off the interest on up to $1.1 million in mortgage debt on your first or second houses. First, you get to write off interest on $1 million in "home purchase debt." Home purchase debt isn't only money that you borrow to buy your house, though. It also includes loans that you take out to improve your house, repair it, or renovate it.  Home equity loans or home equity lines of credit often fall into this category.

You can also write off the interest on an additional $100,000 in "home equity debt." Home equity debt is money that you borrow against your house for any reason, even if it has nothing to do with your house. The IRS doesn't care where the loan comes from. As long as the loan is secured by your home, it's deductible whether it's a purchase mortgage, a refi, a second, or a home equity line of credit.

Discount Point Deduction

If you pay points to buy down your loan's interest rate, they can be deductible, too. The IRS's rules for discount points are a bit fuzzy, but if you meet them, you can save on your taxes. For a new loan, discount points are deductible in full when you take out the loan. With a refinance, though, you have to write off the points over the life of the loan. If you pay $2,000 in points and take out a 15-year loan, you'll get to deduct $133.33 per year every year until you pay off the loan. You also have to pay the points in cash, and they have to be clearly identified as discount points on the closing statement.

Property Taxes

As long as you itemize your deductions and aren't subject to the alternative minimum tax (AMT), your property taxes are deductible. The IRS lets you write them off on as many houses as you want.

Home Office Deductions

If you are have a home office that qualifies, which can happen if you are self-employed and work out of a dedicated space in your house, almost all of the expenses related to your home office are deductible. You can allocate a portion of your property tax and interest to your home office, if you want. You can also write off the cost of anything you provide just for the home office -- like a dedicated fax line. The IRS even lets you write off a proportional share of any other expenses that benefit the home office.

This means that if your home office is 15 percent of your house, you can write off 15 percent of repairs for the benefit of the whole house and  15 percent of your electric bill, among other things. If you don't want to do all of that paperwork, you can also choose to claim a flat-rate home office deduction, although it might be worth less than breaking everything out.

We've linked to the original material from the IRS, but the above information is broad, and may not apply to your specific situation.  You should consult your own tax advisor for specific tax advice to see how this information may apply to you.

How does your house help you save on taxes? Let us know below in the comments section.



4 Things to Do After a Short Sale

Posted by Jordan Blakley

Feb 25, 2014 10:12:35 AM

4729894259_673cba9f36If you've sold your house in a short sale, you aren't necessarily destined to renting for the rest of your life. While you might not be able to move right from the house you sold into a new one that you bought, buying a home after a short sale is something that you can do in time. Here is a simple four-step process that can get you from short sale to homeowner in less time than you might expect.

1. Confirm the Sale Was Reported Correctly

Once the short sale process is finished, ask your lender for a short sale letter. The letter is a document that confirms that you negotiated a short sale instead of being foreclosed on. While you are doing this, order copies of all three of your credit reports -- you're entitled to one free copy of each per year. If any of the reports show a foreclosure rather than a short sale, you can send a copy of the letter to your credit bureau's dispute resolution team and have the report corrected. Keep a copy of your letter, too. You can use it again if your previous house comes up when you are ready for buying a home after a short sale.

2. Manage Your Credit

Short sales can affect your credit as much as a foreclosure does. While the impact can vary depending on your situation, a short sale could affect your score by anywhere from 50 to 160 points. If you go into a short sale with strong credit, it could take up to seven years to recover to what it was before the short sale.

But it won't take seven years for your score to start improving. Taking care of your credit can reduce the damage that the short sale causes and get your score high enough for a mortgage sooner than you might think. While everyone's situation varies, here are a few credit strategies that can help get you on the path to buying a home after a short sale:

  • Pay all of your bills on-time, every time.
  • Be careful applying for new credit.
  • Use as little of your credit limits as possible -- less than 30 percent is good and less than 10 percent is even better.
  • Don't close existing credit cards, since the higher your (unused) credit limit, the better off you usually are.

3. Wait

Most lending programs have waiting periods during which they won't lend to you. Borrowers who go through a foreclosure typically have to wait seven years before they're eligible to apply for a mortgage again. Short sellers, on the other hand, may qualify again after just two years. These programs and rules change periodically, so it's always best to check with an expert mortgage lender. Here are some rules of thumb for different programs:

  • Conventional Loans: Two to seven years, depending on how large of a down payment you can make.
  • VA Loans: Two years.
  • FHA Loans: Three years.

However, if you have extenuating circumstances, both conventional loans guaranteed through Fannie Mae and Freddie Mac and FHA loans can offer shorter waiting periods. The circumstances vary, but can include job loss, illness, or the death of a family member. IF they apply, you could be ready for buying a home after a short sale relatively quickly.

4. Get Preapproved

When you think you'd like to look into buying a home after a short sale, talk to a mortgage lender about getting preapproved. The lender can review the available programs and your situation and let you know if your situation fits with the lender's timeframes. If it does, the loan officer can look at your credit and income, and, if you qualify, get you a commitment. That preapproval lets you shop with confidence and gives you the ability to start writing offers and going back to being a homeowner.

Have you tried buying a home after a short sale? How did it go? Let's talk about it in the Comments section below!



VA IRRRL: The Veteran Refinance Streamline Option

Posted by Jordan Blakley

Feb 21, 2014 12:13:00 PM

VA IRRRL from PennyMacOne of the many benefits current and former service members may have is special financing through the Veterans Administration. Veterans Administration loans, or VA loans, offer simple qualifying terms, low rates, and minimal equity requirements. VA loans do not require mortgage insurance nor PMI if you have less than 20 percent equity in your home. When buying a home, qualifying military personnel may not even need a down payment when working through the VA loan program.

When it's time to refinance, VA borrowers don't have to give up their current loan's benefits. The VA IRRRL -- interest rate reduction refinance loan -- program, sometimes also referred to as a "VA Streamline," lets them easily refinance their VA loan into a new one. Streamline loans usually require less paperwork and have easier credit requirements to qualify than the original loan did. Furthermore, the paperwork is minimal. 

VA IRRRL Basics 

Sometimes also called a "VA-to-VA" loan, the VA IRRRL is designed to let you refinance your veteran home loan to a new one and either lower your interest rate, transition from an adjustable-rate loan to a fixed-rate loan or both. VA IRRRLs are designed to be easy to take out and close quickly. The VA IRRL program requires that there is a net benefit to the borrower either by reducing the loan payment or getting the borrower out of an adjustable rate mortgage. 

VA Requirements for an IRRRL 

The stringent VA requirement to have your Certificate of Eligibility gets waived for an IRRRL. Since you had obtained one to get your original veteran home loan, it gets carried over to your IRRRL refinance loan. Disabled veterans may also qualify for a VA funding fee waiver. 

Loan Terms 

The IRRRL only works when you refinance an existing VA home loan. Currently available only with fixed rates, you can choose any loan term from 10 to 30 years. So, if you're already seven years into a 30-year loan, you can simply refinance your loan for a 23 year term to stay on the same schedule. Thanks to its government guarantee, you can roll all of your closing costs into the new loan. The minimal out of pocket expense allows you to take advantage of the program to lower your monthly payment or convert an adjustable rate loan into a fixed term loan. 

Choosing an VA IRRRL Lender 

The VA doesn't limit your choice of lenders, provided the lender is VA approved. You don't have to use your current mortgage provider or servicer to refinance your existing VA home loan. It’s always best to use a lender that is experienced with the VA IRRRL program as these guidelines do change frequently. The best way to ensure you have the most current information is to contact a lender experienced with VA home loans and find out what the VA requires. 

Qualifying for the PennyMac IRRRL 

When you take out an IRRRL through PennyMac, you get to take advantage of VA lending terms that help you get qualified quickly. The IRRRL can be for up to 100 percent of your home's value, but cannot exceed the original loan amount. Primary, Second and Investments homes are eligible as long as the existing loan already has a VA home loan. There is no prepayment penalty on any of our loans plus we offer bi-weekly payment plan as a convenience for those who want to pay off their loan sooner.

The value gets calculated with a very basic appraisal. The program doesn’t require the lender to calculate debt to income ratio and requires minimal documentation. The VA IRRL program’s main requirement is no mortgage late payments in the last 12 months. 

Do you have questions about VA IRRRL streamline mortgages or about VA home loans in general? If so, ask us below in the comment section and we'll do our best to answer them for you!


Topics: VA IRRRL

New Mortgage Rules

Posted by Jordan Blakley

Jan 30, 2014 4:00:05 PM

mortgage_rules_blog_picNew mortgage rules and regulations went into effect January 2014. The biggest changes involve new rules intended to protect borrowers from loans they cannot afford to repay. Other rules reduce the government's guarantee for mortgages in high-cost areas.

Qualified Mortgage and Ability-to-Repay Rules

On paper, the new Qualified Mortgage (QM) rules from the Consumer Financial Protection Bureau (CFPB) look like they might restrict mortgage availability. New "ability to repay" rules require lenders to review borrowers information to ensure they can afford to repay the mortgage. The Qualified Mortgage is a new category of loan that is supposed to improve the borrower's ability to repay. It has the following features:

  • Have terms no longer than 30 years
  • Have a maximum debt-to-income ratio of 43 percent -- meaning that if you make $5,000 per month, your total debt payments can't exceed $2,150
  • No interest-only periods, negative amortization, or balloon payments (in most cases)
  • Have combined points and origination fees of 3 percent of the loan amount or less (loan amounts below $100,000 have higher limits)

The "ability to repay" portion of the QM rules include the following:

  • The lender must collect and verify your financial information, such as your current income, assets, employments status, credit history, and other debts
  • The lender must look at your assets and income to determine that you can repay the loan

These rules might seem strict, but here's the good news: 87.2 percent of the mortgages made in 2012already complied with these new rules. While non-QM will not be eligible for purchase by the GSE’s or FHA, non-QM loans are not illegal, but their availability will likely be limited to jumbo loans made by larger banks.

Changing FHA Rules

The popular Federal Housing Administration mortgage program is also going through changes. Starting on January 1, 2014, it lowered its maximum loan in high-cost areas from $729,750 to $625,500. This means that borrowers in higher-cost homes may need to find a jumbo mortgage instead of an FHA loan. While this won't affect most American home buyers, it can impact people in high-cost areas like San Francisco, New York, Los Angeles, and Washington DC.

This change is in addition to the higher mortgage insurance premiums that the FHA put into effect in April 2013. Since then, mortgage insurance premiums run 1.35 percent to 1.5 percent of loan balances. Paying these higher FHA mortgage insurance premiums is often the trade-off for borrowers wanting to make the 3.5 percent minimum down payment that FHA loans permit.

The Bottom Line on 2014 Mortgage Changes

These 2014 mortgage changes may affect some borrowers more than others. Self-employed borrowers, small business owners, and people living in high-cost areas could see more impact than other borrowers. The description above is a high-level summary - you'll want to talk to a licensed loan officer to see how these rules affect your situation. 

How do you see these changes affecting you? Let us know below in the comments section.


PennyMac for iPhone Gets Rate Alerts, Product Descriptions, and Expanded Product Set

Posted by Jeremy Bachmann

Jan 24, 2014 10:52:01 AM

Today, PennyMac for iPhone gets a number of significant enhancements to let you receive rate-change alerts, view in-depth product descriptions and benefits, and obtain rates for even more products.

Get PennyMac for iPhone

Receive Rate Alerts

Many PennyMac customers and prospects have a target rate they must hit to receive a benefit from refinancing or to qualify for a loan. Now, you can set a target rate in your profile and receive notifications on your iPhone when our rates hit your target. From there, you can click one button to reach a PennyMac loan officer to get started.

Rate alerts are saved in a pull-out drawer on the right-hand side of the application. Each alert is time-stamped with the time of the particular rate quote.


Expanded Product Set

On some mortgage applications, customers with larger loans mistakenly receive jumbo quotes, showing higher rates than the customer is likely to pay. PennyMac for iPhone shows rates by county, allowing us to show more accurate conforming high-balance quotes for customers.  We also allow customers to enter loan amounts higher than their home value, so they can see possible HARP loan quotes (and call our loan officers for more information about qualifying).

Enhanced Product Descriptions

Along with this expanded product set, you can now tap on a product in the My Rates tab to display a product description, including features and benefits.


Other Improvements

We've created a new tabbed user interface to give you an overview of PennyMac for iPhone's main content. Also, you now can save PennyMac's sales and servicing contact information into your iPhone address book, so sales or customer service help is always at your fingertips.

You can download the application onto your iPhone here or by opening the AppStore from your iPhone and typing "pennymac" in the search bar.


Mortgage Loans for the Self-Employed

Posted by Jordan Blakley

Jan 22, 2014 2:53:49 PM



Getting a mortgage might be harder for self-employed people, but borrowers around the country do it every day. The self-employed borrower needs not only to provide tax returns but to confirm them with Form 4506-T. This makes the process of qualifying for a mortgage loan run up against the usual strategy of minimizing income for tax purposes. With planning, though, you can live the American dream of owning a house and being your own boss.


How They’re the Same

Self-employed borrowers can apply for the same mortgage programs as anyone else.  Common loans programs such as conventional loans and FHA loans (including FHA streamline loans) are available to the self-employed, and in traditional terms such as the 15-year or 30-year loan. 

Whichever mortgage you choose as a self-employed person, the lender is going to use the same general mortgage underwriting procedure to decide whether or not to lend to you. Underwriting relies on three primary factors -- your capacity to repay, your credit history, and the strength of your collateral.

  • Capacity To Repay. To calculate your capacity to repay, lenders look at the relationship between your income and your debts. Your front-end debt-to-income (DTI) ratio comes from dividing your proposed mortgage payment into monthly income, while your back-end DTI comes from dividing all of your monthly payments into your monthly income. When you're self-employed, the income is usually based on an average of your preceding two years of income as reported on your tax returns. In addition, the lender will also look at your bank accounts to determine what reserves, if any, you have.
  • Credit History. Mortgage lenders look at your credit score just like with any other type of borrower. If you have a good history of managing credit and paying back loans, you are more likely to be approved.
  • Collateral. Your lender will also pay careful attention to the value of the property that you are pledging as collateral. Generally, the underwriter will order an appraisal to ensure that its value supports the loan that you are seeking.

How They're Different

They key difference with a self-employed mortgage comes from how your income is analyzed. With a typical mortgage, the lender will usually look at two months of pay stubs to determine the applicant's income. Those pay stubs show the worker's gross income before taking out any deductions.

When you're self-employed, lenders don't have W-2s to use. Instead, they look at your last two year's tax returns. They don't look at your business' top-line income. To get a self-employed mortgage, your debt-to-income ratio gets calculated on your business' bottom line -- its profit after expenses.

If you're like most self-employed people, you maximize your business expenses and other deductions. Within the law, you might write off a portion of your home's operating costs, mileage for your car, and even the business portion of personal trips. Some or all of your cell phone bill probably is deductible, too. All of this leaves you with a lower taxable income than you'd have if you were a salaried employee. Unfortunately, lenders don't take this into account. They usually judge you based on your bottom-line income.

Getting a Mortgage While Self-Employed

Self-employment isn't an insurmountable barrier, however. There are a few strategies that you can use to help you qualify for a mortgage loan:

  1. Buy a house that you can afford taking into account the lower income that the lender will calculate.
  2. Put more money down to reduce mortgage and PMI payments.
  3. Ask your financial adviser about taking fewer deductions or other strategies to increase your income. You pay more taxes, but your income may be closer to one that enables you to get your mortgage.
Have you gotten a self-employed mortgage? How did you do it? Let us know in the comments section.

7 Ways to Protect Your Credit Score When Applying for a Home Loan

Posted by Jordan Blakley

Jan 15, 2014 4:46:12 PM

blog_picYour credit score is one of the most important parts of getting a mortgage, but it's also one of the easiest parts to control. Making small changes in how you handle your debts -- some of which won't even cost you anything -- can make a difference in your score, and get you qualified or get you a lower interest rate. Take steps to minimize your stress about getting a home loan.

Here are seven ideas for how you can positively impact your credit report and get approved:

  1. Do no harm. The first factor to keep in mind is that you don't want to do anything that could change your score negatively during the home loan process. Keep paying your bills on time, don't change your job, don't take out new debt and don't increase your debt balances.
  2. Fix credit report errors. If there are errors on your credit report, one of the best ways to improve your credit is to work with the companies that report them to get them corrected. Your loan officer may be able to help you build a strategy to determine which errors to work on first, as well. 
  3. Pay down credit card balances. Paying down balances may help you in two ways. First, it lowers your monthly payments which can make your debt-to-income ratio look more attractive. Second, it lowers your credit utilization rate, which can make your credit score go up. The less of your credit you use, the better the risk you become.
  4. Bring past-due accounts current. If you have accounts that are late but that have not yet gone into collections, bringing them current can stop them from doing more damage to your credit report. As they transition back into on-time status, it could stop them from hurting your score further. 
  5. Use your credit cards less. Another way to show lower utilization is to simply use your credit cards less. You can simulate lower credit card usage by paying them down in the middle of the month. That way, your statement shows lower balances.
  6. Increase credit limits. Another way to make your utilization look better is to call your credit card lenders and ask for a higher credit limit. If you owe $1,000 on a $2,000 limit, you're using 50 percent of your limit, but if you can get an increase to $3,500, your utilization drops to 28.6 percent. Be careful doing this as your credit card lender may pull a "hard inquiry" that shows up on your credit report.
  7. Apply for a new credit card. While the usual rule of thumb is to not change anything about your credit, adding an additional credit card can be one of the ways to improve your credit since it also lowers your credit utilization. To make sure that this strategy is appropriate for you, talk to your loan officer before making any applications.

Have you successfully fixed credit problems and turned a mortgage denial into an approval? Do you have any other ideas? Let us know below!


Topics: buying a home, credit score

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