When you apply for a mortgage, your lender will request a great deal of paperwork from you. This will include looking at your income, assets and existing debt - as well as your credit-worthiness.
As a part of the mortgage loan process, the mortgage lender, along with the underwriter of the loan, will request verification of the assets and income that you say that you have.
As a part of the verification process, certain terms and questions may arise. Here are a few;
The Ability to Pay Rule
Subprime mortgages accounted for a significant proportion of the recent housing crisis. During the housing boom, many people who could not realistically afford specific mortgages were approved for them anyway. The federal government passed legislation in 2013, often referred to as the “Ability to Pay Rule” to help prevent a housing crisis from happening again.
This legislation, under the Truth in Lending Act, requires underwriters to look at eight factors when determining your ability to make particular payments:
- Your current or expected income
- Your current employment status
- Your expected monthly mortgage payment
- Your monthly payment for a second mortgage on the same property (if there is one)
- The monthly payments for insurance, property taxes and homeowners association dues
- Your debts and any alimony and child support
- Your monthly debt-to-income ratio, and
- Your credit history
Your mortgage lender may use other factors to look at your credit-worthiness as well, but lenders typically look at these eight items, which define the, "Ability to Pay" rule.
What Information Will The Mortgage Lender Request?
The mortgage lender uses varying sources to more closely examine and verify the eaight factors above that make up the Ability to Pay Rule. As a general rule, when you apply for a mortgage loan, you will be asked to provide the following documents:
- W-2 forms from the past two years
- If self employed, form 1099's and profit and loss statements for your business or self-employment income
- Borrowers paycheck stubs from the past month
- Bank statements (with information about any unusual or large deposits)
- Tax returns from the previous two years
- Evidence of all debts, including student loans, credit cards and child support
- Balances and minimum payments on all debt obligations
- Proof of rent or mortgage payments (through bank statements or canceled checks)
The mortgage lenders may also request you to sign a form allowing them to access your tax returns directly from the Internal Revenue Service (IRS).
How Does a Borrower Prove Work History if Changing Jobs?
Most borrowers prove current employment with recent paystubs. However, this is not particularly useful for borrowers that are moving or switching jobs. In this case, the lender may give you what is known as an "Offer Letter Mortgage". This means that you can use your new job offer as a proof of employment and a way to establish your future income as well. However, be sure and get a solid job offer letter. Lenders may not accept a letter or email stating the new job may or may not be available or be available at sometime in the future.
Proving future income from a job offer letter is particularly important for people who might be receiving large increases in income from a promotion or new employment - or for recent college graduates that may not have been working while in college. Borrowers can also use a notification of future if you get a raise or promotion from your current job and you would like the future income figured into your debt-to-income ratio.
What Paperwork is Needed for Self-Employed Borrowers?
There's a lot of information you'll need to present to your lender. Keeping everything organized will save you time and headaches as you move forward!
Fortunately, paperwork requirements for self-employed borrowers have loosened recently, with new guidelines from Fannie Mae. In the past, mortgage lenders may have required two years of self-employment income, with profit and loss statements. As of this year, many lenders may only request one year, which allows new business owners to apply for a loan sooner.
Does a Mortgage Loan Require Reserve Assets?
For many reasons, mortgage lenders may require verification that you have certain assets readily available to make the down payment, closing costs and other relevant expenses at the time of closing. The term “assets in reserve” refers to liquid assets (or assets that could be readily accessible at virtually any time) that are in your possession. Your lender may ask for a greater reserve of assets if you have a weak employment history or if your credit is a little lower than preferred.
Additionally the mortgage lender may request that you have the asset reserves or cash-on-hand available to make the minimum monthly payments for 3-12 months after closing, depending on the terms of the specific offer. For this calculation, each month’s mortgage payment is the sum of required payments for principal, interest, taxes and insurance. This reserve is intended to act as a protection for your mortgage, in the event that your earning potential is cut short due to job loss or disability.
What Assets Are Verified?
A borrowers assets are not always just limited to the cash in a bank or savings account. If you already own a home and are in the process of selling, often times the lender will allow you to use a seller’s net sheet that will show the expected cash at closing from the home sale. Other forms of assets count as a reserve, such as:
- retirement funds from a 401k or independent retirement account (IRA)
- stocks or mutual funds
- money held in savings
- gifts from immediate relatives
During the mortgage application process, you will provide recent bank statements, usually from the past 3-6 months. You will typically be expected to document and explain any large deposits that are not proven by a pay stub or business income.
It is not uncommon for some borrowers to receive a gift from a relative to help pay the down payment or closing costs. However, your lender may request that the giver sign a document verifying that they gave the gift freely and do not expect it to be repaid.
What is a Stated Income or Stated Assets Loan?
Since lenders are required to look at income during the underwriting process and typically will also look at assets, you may wonder about the purpose of loans that do not ask to prove income or assets. These types of mortgage loans have greatly decerased since the housing crisis and are not offered by many mortgage lenders. However, should they be available, these loans can be useful for people who are self-employed, with an inconsistent monthly income but a stable yearly income. Lenders who offer these loans usually require that applicants make a larger down payment and provide greater-than-usual documentation of their ability to pay the monthly payments.
The underwriting process for your mortgage loan is a crucial step to determine if a mortgage borrower can afford the mortgage as offered. The information you provide to your lender as part of your application helps to ensure that you are a worthy borrower who will make the payments on time every month.
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