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If you are building a home and need a mortgage, the first step in the process is to talk with a lender and get qualified for a mortgage. With that information, you will know your budget and are ready to start planning for your new home. But for some, the lender may give them some bad news. They don’t qualify for a mortgage and their dreams of building are dashed. Here are the top 7 reasons your mortgage request could be denied.
Reason #1 – Debt-to-Income Ratio is Too High
In a report from the National Association of Realtors (NAR), the main reason homebuyers of all ages reported having their application rejected was their debt-to-income (DTI) ratio. Thirty-five percent of overall respondents cited this reason. Debt that you owe makes up half of the picture of your debt-to-income ratio. The less you owe every month, the more income can go toward your house payment. It doesn’t matter what you think, it matters what the lenders thinks you can afford to repay each month for your mortgage. There are two ratios used to determine that for you. They are typically known as your front-end ratio and your back-end ratio.
The front-end ratio is calculated by dividing your projected monthly mortgage payments by your gross monthly income (your income before taxes). Your projected mortgage payment will include the costs of the principal, taxes, insurance, and interest payments, collectively known as PITI.
Your lender will set the terms, or the limits, for conventional loans. Depending on the lender, expect a limit of 28% for the front-end ratio. Federal Housing Administration (FHA) loans allow for a maximum front-end ratio of 31% as of 2018.
The back-end ratio accounts for all of your debt payments in comparison to your income. Your lender will calculate this ratio by adding your monthly debt payments and then dividing that number by your gross monthly income. These debt payments include the PITI on your mortgage, child support, car payments, credit card minimum payments, and any student loans.
Most conventional lenders prefer to see a back-end ratio under 36%. Per FHA guidelines, lenders cap your total DTI ratio at around 43% — including your future house payment. So the lower your other minimum monthly payments (credit cards, student loans, car payments), the more house you can afford.
Reason #2 – Low Credit Scores
The second item on NAR report was “Other.” But after that, low credit scores caused the most rejections. Mortgage lenders use your credit score to decide whether to approve you and at what rate. Construction loans typically require a higher credit score because, in their mind, the lender is taking more risk. Your credit score is the key indicator to a lender about what kind of risk you are as a borrower.
As part of your credit score, they will also look at things such as foreclosures, missed or late payments, and bankruptcies. While many people will use websites like CreditKarma.com or CreditSesame.com to track their credit score, the score those sites use isn’t the one that the lender will use in determining your credit score. Those sites use the VantageScore 3.0 score. Your lender will use your FICO score. More specifically, they will use a specific version of your FICO score that tries to predict how well you will make your mortgage payments if they provide you with a loan.
Getting ready for a mortgage – You want the highest credit score you can have when you apply for a mortgage. In addition to determining if you meet the minimum credit score requirement just to qualify for the loan, it also is used to determine the interest rate you will get. A lower score means a higher interest rate. A higher interest rate can impact your debt ratios (which we will discuss later). Your FICO score should be around a 680 minimum for getting a construction loan. Some lenders may want to see a 700+ FICO score. Pay down debts and make all of your payments on time leading up to applying for a home mortgage.
Reason #3 – Unable to Verify Income
Next on the NAR report was the inability to verify income. This typically impacts those that are self-employed. It’s not what you say you made; it’s what you reported to Uncle Sam on your tax return that counts. Many self-employed applicants may under-report their earnings. While that may be to their benefit at tax time, it can sink the opportunity to qualify for a mortgage.
Lenders like to see the last two paystubs and want two years of tax returns to verify employment and income. If you don’t fit in that box as a self-employed applicant, your chances of being approved are reduced. If you are self-employed, make sure that you fully report income, especially in the two years leading up to your planned home build. If possible, have your business issue a regular paycheck versus making an owner withdrawal. Following these suggestions can avoid the unverifiable income dilemma for self-employed borrowers.
Reason #4 – Insufficient Funds for Down Payment
Historically, you needed a 20% down payment to purchase a home. This means that if the home price was $250,000 you needed $50,000 to buy the home. If you are a move-up home buyer and you have equity in your previous home, then $50,000 may not seem like much of an obstacle. Most first time home buyers list the ability to come up with a down payment as the #1 hurdle to homeownership. However, there are many government-backed programs that can lower that amount.
Some of the mortgage programs requiring the smallest down payments are FHA, VA and USDA.
- FHA loans require 3.5 percent down for applicants with credit scores of 580 or higher.
- FHA borrowers with lower credit scores (500 to 579) must put at least 10 percent down.
- Eligible VA loan borrowers can get mortgages with zero down (100 percent LTV).
- Eligible USDA borrowers can also borrow 100 percent of the property value.
If you need to get funds to meet down payment requirements, borrowing the money is frowned upon. Hiding money under your mattress isn’t acceptable. The funds must be in your account for at least 60 days prior to closing. Gifts may be an acceptable source to meet down payment requirements. Money that is gifted can come from a relative or close family member. However, it must be documented and allowed under the lending program.
Reason #5 – Unpaid Tax Lien or Judgement
Having an unpaid tax lien or judgment can sink your mortgage application. The worst part is that many times they may not be on your credit report. Because the lender can easily find them, they may not be discovered until late in the process. They can come up right before your closing and end your mortgage process.
Lenders are required to have a title search done prior to closing, and the title search will find any unpaid federal or state tax liens as well as any outstanding judgments. If you can’t afford to pay them (and not mess up any of the other ratios or asset requirements), you won’t be able to close on the loan as they won’t be able to issue a clear title policy to your new home.
Reason #6 – Not Having Enough Savings or Assets
The lender not only wants to make sure you have the down payment for a home, but they also want to make sure you have enough funds in reserve to pay your mortgage payment. They want to make sure you can have the funds to make payments, usually for 6 months, in reserve. When you build a new home, it is essential to make sure you have reserves to weather the unknown storm.
Reason #7 – The Property Doesn’t Appraise for the Sales Price
After the great recession, it was common for homes to not appraise for the sales prices. It wasn’t because the home wasn’t worth the price. It was because economic conditions had driven all home values down. Basically, an appraisal works by taking the value of like properties in the area surrounding the home site and averaging them. As the economy boomed, house prices have risen. In many areas, they are higher than ever. The benefit of building a custom modular home is that with the efficiency of the factory, a home may appraise for 5-15% more than the sales price. That is the value of modular construction!
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