Low doc loans still exist, contrary to popular belief. They just aren’t as widespread as they once were, especially after the housing crisis. Lenders are starting to realize that there are still people that need these low doc loans in order to get financing. The most common people are the self-employed and the retired.
In order to get the low doc loans, though, lenders typically look for compensating factors. These are factors that ‘make up’ for the fact that you need a low doc loan. Keep reading to learn the most common compensating factors that lenders want to see.
Great Credit Score
Your credit score can speak volumes to a lender. A great credit score lets a lender know that you are financially responsible. You make smart financial choices, you don’t overspend, and you pay your bills on time. Despite the fact that you need a low doc loan, the high credit score can let a lender know that you are a good risk.
Just what constitutes a great credit score? It really depends on the lender, but typically they want a 720 credit score or higher to consider it ‘great.’ If you have a credit score of this magnitude, you may be able to get a mortgage without a lot of documentation.
A Lot of Reserves
Reserves are money you have set aside that you won’t use for the purchase transaction. In other words, it’s an emergency fund that you have set aside. Lenders like to see reserves because it gives them peace of mind that you will be able to pay the mortgage even if something happens to your regular income.
Lenders measure your reserves based on the number of mortgage payments it covers. For example, let’s say that you have $10,000 in reserves and your mortgage payment is $1,000. You have 10 months of reserves on hand or you can cover 10 months of mortgage payments.
There isn’t a certain amount of reserves that you must have on hand – but obviously the more you have the better your chances of approval. Lenders typically like to see at least six months of reserves on hand, but if you have more, it can only help your chances of getting approved.
A Large Down Payment
Lenders want to know that you have an investment in the home. If you only put a small amount of money down, it may not be incentive enough to keep making your payments if something happens to your income.
The more money you can put down on the home (from your own funds), the lower the risk of default becomes. For example, let’s look at the difference between a 3% down payment and a 15% down payment.
If you want to buy a $250,000 home, you would put down $7,500 for a 3% down payment and $37,500 for a 15% down payment. That’s a big difference. If your business folded and it became difficult for you to make your mortgage payments, you might consider walking away from a $7,500 investment, but a $37,500 investment would be a lot harder to walk away from in most cases.
Each lender has a specific amount that they want you to put down in order to compensate for the low doc loan. Usually down payments of 20% or higher are highly desired, but any amount that you can put down that is above the minimum requirement can be a compensating factor.
History in the Industry
If you are self-employed, it helps if you have a long history in the industry that your business is in. This gives the lender reassurance that you have what it takes to succeed as a business owner. If you don’t have the right experience because you just entered the industry, it can be a red flag for a lender as they try to determine if you will succeed or not. Since no one can predict the future, they go off your past and without a past for them to evaluate, they may not want to take the chance on your low doc loan.
Each lender will have their own requirements and have a different threshold on what they consider compensating factors. If you need a low doc loan, talk to various lenders. See what they require and what they would consider ‘a compensating factor.’ You can then compare the costs and the interest rates offered by each lender to help you decide what will work for you.