Don't Make The Mistake of Assuming a Client Qualifies for Financing
Based on Lots of Equity in the House
A family law attorney gave me this idea. “Noel,” she says (allow me to paraphrase), “a lot of us assume that if there is a lot of equity in a house then financing is a slam dunk…we just assume it can be done.” This was in response to bad news (which is never final or ultimate with me) I had given her about a client who had applied for financing. The disqualifying features of this client's loan were credit and debt/income ratios or, as the CFPB likes to call it, ATR (the Ability To Repay).
It is at this lawyer’s bidding that I write this article. The solution for that particular case? See the last paragraph.
A few things to keep in mind when trying to evaluate a client’s ability to obtain mortgage financing. Well, there really is only one thing to keep in mind…
972-724-2881 (and let me handle it).
But, other than shameful promotion of what I do, here are some elements to keep in mind:
There are 5 + 1 elements to mortgage loan approvals that have been constant. Have a passing knowledge of these features and you will know a whole lot about why some people get loans and others do not. They are:
1. Credit patterns – which measures the willingness to repay debt
2. Income Stability – which measures the ability to repay debt
3. Ratios (Loan To Value; Debt) - which measure the relative risk of lending on a property to a borrower
4. Property – which measures the worthiness [not just dollar value but condition, type, etc.] of the lender’s collateral (collateral makes mortgage money relatively cheap)
5. Money to Close – which measures whether or not a borrower can consummate the transaction and has “reserves” to cover a certain amount of payments (usually 2 months or, at the most, 6).
6. Compliance – which is the “not-without-which;” it doesn’t qualify the applicant but there is no legal way to advance the loan without it.
Takeaway: If one assumes that a large amount or percentage of “equity” in a property (#3, low LTV ratio) automatically qualifies a prospective borrower, one ignores 4 other equal and critical factors in loan approvals.
Here’s something else to keep in mind, especially in divorce. Notice that there is no “asset-only based” lending in the above list of qualifying features. That is, even if a person has a certain amount of money, this still does not qualify them to repay the loan. People are often frustrated by this like the guy who told me “Good grief, I have $350,000 in the bank, does the lender really think I can’t pay this $100,000 mortgage;” to which I replied “how does the lender know you will not buy a Lamborghini and drive off into the sunset if you wake up and decide you don’t want to spend your money on house payments?”
The borrower has to have the ability to repay the loan.
Moreover, the lender cannot accept that the financed property has a lot of equity in lieu of the borrower’s ability to repay the debt. That’s called predatory lending and, on the other side of the deal (when lenders are foreclosing on said property) all of the sudden lenders become the devil because they took advantage of borrowers just so they could scoop up a property with a lot of equity that they turn around and sell for a profit. All that is, of course, ridiculous. But, if you were paying attention in 2008 and after, you heard this quite a bit; and the villain? Lenders who lent money to people who allegedly didn’t have the ability to repay it.
So, now it’s a matter of law. It's commonly referred to as ATR - Ability to Repay. And it makes a huge difference in who gets loans and who doesn't.
I cannot take the space herein to explain the pros and cons of collateral based lending and asset based lending. Suffice it to say for now – it doesn’t really exist though I hope it makes a come-back under prescribed conditions.
Here’s what I’ve seen in the past 15 years working at the intersection of divorce and mortgage finance. Income stability is the factor that requires the most work. Credit can be fixed in nearly all cases; although, it could take up to 2 years or so for some dire situations to be rectified.
But, establishing the right debt:income ratio is one of the biggest tasks. I say ratio because, everything is relative and expressed in percentages in mortgage qualifying.
Fortunately, that’s one of my specialties.
The income stability issue is related to the ratios. But, it is substantive, not mathematical. That is, not all income is considered “qualifying” income in mortgages. So, before we consider income we have to establish the source and type – the stability of the income – its substance.
Here are a few guidelines that illustrate that concept:
- Part time income is only considered qualifying if it has been received for two years and from the same job
- Income after a “job gap” (think stay-at-home mom who goes back to her prior profession) often has to be received for 6 months before considered qualifying.
- Support income that is ordered in a decree that expires before 3 years is not considered qualifying.
- Support income that has not been received (and documented) for 6 months is not considered qualifying.
This is a good time to let you know that you can host a CLE accredited presentation at your firm, practice group, bar association, family law section meeting. The course on Owelty Liens is always requested. But, the one on Credit and Mortgage Qualifying in Divorce is equally important and helpful. It will arm you with some great information at the mediation or negotiation table.
Call or email Elizabeth Duane to schedule this or any of our CLE-accredited presentations.
That’s enough for now. I’ll write more about this in just a bit. Thanks for reading.
Last Paragraph - the solution to the initial problem: At least for me, it's simple. We begin fixing the credit. This takes some work but we've become adept at predicting about how much time it will take. Even the worst situations can "climb out of the whole" within about 2 years. Then, I outlined how to structure the child and spousal support and recommended a documentation regimen that provides what we need for loan conditions. Mix, Stir, Shake, Monitor Progress. Close Transaction in about 6-12 months.
You can always contact me with questions at 972-724-2881 or at Noel@TheMortgageInstitute.com