Non-Qualified Loan

Mortgage Commitment Letter and Pre-Qualification Letter: The Differences

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When you apply for a mortgage, you will hear a lot of different terms thrown around. Understanding these terms and how they affect your bottom line will help you get the mortgage that you need. Two of the most confused terms in the mortgage industry are mortgage commitment letter and pre-qualification letter.

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Below we help you differentiate between the two terms.

What is the Mortgage Commitment Letter?

The mortgage commitment letter is often confused with the pre-qualification or pre-approval letter, but it is neither of those things. The mortgage commitment letter is a final commitment from the lender that they plan to give you a loan barring any unforeseen circumstances.

Typically, the lender doesn’t write up the mortgage commitment letter until your loan file goes through the following:

  • Complete the loan application and provide the proper documentation including your paystubs, W-2s, tax returns, asset statements, and credit report
  • The underwriter evaluates your application and supporting documents. The underwriter will make sure everything matches what you said. They may ask for more documentation during this time or ask for more clarification on what you did provide.
  • The underwriter evaluates the appraisal. They need to make sure that the home is worth at least as much as you agreed to pay for the home. The underwriter must also make sure that the home passes any of the specific loan program requirements.

Once all of these steps are complete, the lender may be able to write up the commitment letter. The letter may include a few conditions, but they aren’t anything major, like the appraisal. The conditions may be about your proof of insurance, an additional bank statement, or one last paystub just to prove that you are still employed by the closing.

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What is the Pre-Qualification Letter?

The pre-qualification letter is almost the exact opposite of the mortgage commitment letter. The pre-qualification a lender provides you with has no merit behind it. The lender gives their best estimate on how much loan you can afford based on the information you provide.

The main difference between the pre-qualification letter and the mortgage commitment letter is that there isn’t any substantiating evidence behind the pre-qualification letter. You don’t have to provide the lender with any evidence of your income or assets. You tell the lender how much you make each month, how much you have saved for a down payment, and what debts you have. The lender will pull your credit to see your credit score and to check your debts, but that’s the only official evidence they have with a pre-qualification.

Basically, the pre-qualification letter is a lender’s intent to provide you with a loan of a specific amount, but it is contingent on a large number of conditions. It’s often the first step in the process, but it doesn’t hold any weight, even when you shop for a home.

The Pre-Approval Letter

The step in between the pre-qualification letter and the mortgage commitment letter is the pre-approval letter. This letter is proof of the lender’s intent to give you a loan, but it’s typically based on a few conditions that don’t have anything to do with the borrower himself, but rather the property.

In order to get a pre-approval letter, you must apply for the loan and supply any borrower-related documents, such as your paystubs, W-2s, tax returns, and asset statements. The underwriter will review these documents and conditionally approve you for the loan. As we stated above, the conditions are usually related to the property including:

  • Appraisal
  • Title work
  • Homeowner’s insurance
  • Flood insurance

The pre-approval letter is what sellers want to see because it helps them know that you are a serious buyer. Without the letter, they don’t know if you can even get the financing that is necessary to buy the home. While it’s not the mortgage commitment letter, it’s more than just a prequalification letter.

If you are ready to buy a home, you want the pre-approval letter. If you are just starting out and have no idea what you can afford, the pre-qualification letter will suffice. If you already signed a purchase contract and have a closing date, that mortgage commitment letter is the only way you will get to the closing.

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What Compensating Factors do you Need for Low Doc Loans?

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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.

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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.

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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.

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Watch Out for These Common Mortgage Pitfalls

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Hearing the words ‘you’re approved’ from a lender can be exciting and overwhelming at the same time. Just because you get approved for a mortgage doesn’t mean that you have to take it. All too often, borrowers make mistakes that cost them thousands of dollars and even their good credit history.

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Lear the top mortgage pitfalls many borrowers make to help you avoid these issues yourself.

Taking the Full Loan a Lender Offers

When you apply for a pre-approval from a lender, they qualify you for the maximum amount of loan you can afford on paper. Notice that we said on paper. The lender qualifies you based on your debt ratio, credit score, and income. This doesn’t mean you have to take the full loan amount, though.

Before you accept a loan amount, look at the numbers ‘in real life.’ Don’t just take a lender’s word for it. Take the mortgage payment and see how it fits into your budget. Can you comfortably afford your other monthly payments? Do you have discretionary income available still? Is the amount much higher than you anticipated? Just because a lender says you can have the higher loan amount doesn’t mean you have to take it.

The amount the lender offers is the maximum loan amount you can have. Accepting the maximum loan amount could make you ‘house poor.’ In other words, it may get difficult to make your mortgage payments, forcing you to regret your home purchase. Don’t let that happen to you.

Taking the First Offer you Receive

Again, hearing the words ‘you’re approved’ can make you jump for joy. Before you take the first loan you get approval for, though, take the time to shop around. How do you know that the terms and rates the first lender offers are the best available to you?

We recommend applying with at least three lenders. This way you can compare the loan offers. Look at the terms, first. Are they all offering a fixed rate loan or is a lender giving you an adjustable rate loan? What about the length of the term, are they all 30-year loan terms or are some lenders offering shorter terms?

Finally, look at the interest rate and closing costs. Compare them side-by-side. You may notice that the lender that offers the lower interest rate charges much higher closing costs and vice versa. You want to find the lender that offers the loan with the costs you can comfortably afford.

Looking at the big picture from all of the offers will help you choose the right loan. Choosing the first offer you get could force you to pay much more than necessary for closing costs or provide you with less than optimal terms. Take your time and find the loan that’s right for you.

Not Knowing Your Credit Score

You should be an informed borrower before applying for a mortgage. A big part of this means knowing your credit score. Lenders use your credit score as the basis for determining your approval. A low credit score can leave you with less than optimal terms and higher interest rates. A high credit score may offer you more opportunities for more affordable terms and lower rates, though.

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If you don’t know your credit score, you won’t know what to expect from lenders. Don’t assume lenders will be honest and give you the best terms available to you based on your qualifying factors. Know your credit score so that you can negotiate appropriately. If you know you have great credit, ask for the lower rate, or ask for fewer closing costs. If you know your credit needs some work but you need a mortgage now, negotiate accordingly, asking for help with closing costs or for a lower interest rate by paying a discount point.

If you know you have a low credit score and you have time to fix it, do it. Get caught up on your bills and pay your credit card balances down. Don’t apply for new credit and make sure you have a good mix of installment debt and revolving debt for the best impact on your credit score.

Not Knowing Your Cash to Close Requirements

Your down payment isn’t the only money you need to close on a home purchase. You have to pay the closing costs too and they could cost as much as 5% off your loan amount. This could add thousands of dollars to your cash to close.

Ask your lender upfront how much the closing costs will run you. By law, the lender has to provide you with a Loan Estimate within three business days of you applying for the loan, but you can also ask your loan officer about the closing costs for more clarification.

If you find that you don’t have the cash to close, as the lender about your options. Typically, they allow:

  • Receipt of gift funds from a relative or employer
  • A no-closing-cost loan in exchange for a higher interest rate
  • Seller concessions to help with the closing costs

The sooner that you know about the closing costs the more time you have to figure out a plan. Finding out at the last minute that you need a few thousand dollars can just add to the stress of getting a mortgage.

Not Having Seasoned Funds

When you put money down on a home or pay the closing costs yourself, you need seasoned funds. This means funds that sat in your account for at least two months. Lenders consider this enough time for any potential loans that you have to provide you with the funds to show up on your credit report.

This means that you can’t make a large deposit within two months of applying for the loan and expect the lender to accept them. You will have to provide proof of where the funds came from and how you got them. Lenders need to know that there isn’t another loan out there that will affect your debt ratio. If they can’t prove the origination of your large deposits, they may not allow you to use the funds for closing and/or the down payment.

Don’t make these common mortgage pitfalls. Take your time and shop around for the right loan for yourself. Talk with lenders and find out what requirements they have to help you get through the mortgage process with as little stress as possible.

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The Top Reasons Underwriters Need a Letter of Explanation

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The mortgage process can feel like a serious of questions that never ends, but it’s for good reason. Lenders need to make sure you can afford the loan beyond a reasonable doubt. The last thing you or the bank wants is a foreclosure.

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After you provide documentation for your income, assets, and liabilities, expect to answer questions about certain areas of your life, most notably your bank account, credit and job history. Sometimes lenders ask questions about these factors that require a Letter of Explanation. All an LOX does is put into writing the reasons for your current situation that may need a little more explanation.

So why do lenders ask for a Letter of Explanation? Check out the top reasons below.

You Change Jobs Often

Lenders want a consistent job history. While a 2-year history is recommended, if you changed jobs within the last two years it doesn’t automatically mean you won’t get approved. When lenders get the most concerned is when you changed jobs frequently within the last two years or if you completely changed careers within that time.

Let’s look at an example. You used to be a teacher but decided to get trained as a real estate agent last year. Those are two completely different career paths and since your real estate career is rather new, a lender may worry that you won’t succeed. You may need to write a Letter of Explanation stating your reasons for changing careers as well as what training you underwent so that you succeed in your new career.

If you didn’t change careers, but change jobs often to the point that a lender considers it ‘job-hopping, they may want an explanation for your actions. In other words, they want to know why you keep leaving your job (is it forced or voluntary) and what you benefit from leaving and starting a new job.

Lenders use these answers to decide if you are a good risk for a loan or if you are a high risk of default.

You Have Large Deposits

If you make large deposits in your bank account within two months of applying for a loan, you’ll have to explain it. If a lender can’t tie the deposit in with your employment income, they’ll need concrete proof of its origination.

Along with the paperwork proving the funds’ origination, lenders will want a Letter of Explanation. The LOX should state where you obtained the funds and why. If you don’t have proof of your explanation, a lender may not be able to accept the deposit as a part of your funds. For example, if you claim you sold your car and received cash for it, but you don’t have a Bill of Sale and/or a canceled check from the buyer, the lender may not be able to use the funds for qualifying purposes.

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Late Payments

Lenders look closely at your credit score and credit history. Your credit history actually tells them a lot more about your financial responsibilities. If upon looking at your history they see many late payments or collections, they may want an explanation.

For example, some people fall onto hard times and make several payments late within a short period. This may be easily explained with a Letter of Explanation. For example, if you fell ill and were in the hospital, it would make sense why you were unable to pay your bills on time for that short period. An LOX could explain the situation and if you could provide proof of your downfall as well as how you picked up the pieces, it would help your situation.

Lenders need to know that late payments aren’t a typical habit and that this was a one-time occurrence, which you can prove with your LOX.

Change in Income

If you’ve had a change in income recently, and it wasn’t a raise, you’ll need to explain the situation in a letter. All lenders see is a drop in income, which makes them want to decline your loan. But, if you have a valid reason, such as you started a new career or started at a new company that has more opportunities for advancement, an underwriter may see the value in it and approve your loan. Without the letter, the lender would see you as a high risk of default and decline the loan.

A good Letter of Explanation can be the difference between loan approval and loan denial. Stay in close contact with your loan officer to find out what questions the underwriter may have on your loan so that you can clear up any miscommunication right away and keep your mortgage approval.

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Understanding the Mortgage Loan Approval Process

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The mortgage process can be overwhelming, especially your first time around. Knowing what to expect can take a little anxiety out of the process. With the right knowledge and steps, you can easily get through the mortgage process with ease.

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The Preapproval

The first thing you should do is get a preapproval. This is when you apply with different lenders to see if they will give you the loan you need as well as at what terms/cost. The preapproval process involves you providing the lender with the following:

  • Paystubs for the last 2 months
  • W-2s for the last 2 years
  • Tax returns for the last 2 years if you are self-employed or work on commission
  • Asset statements for the last 2 months
  • Contact information for your employer
  • Consent to pull your credit

Giving a lender these documents now will give them time to evaluate your situation. They will determine your credit score, debt ratio, and amount of money you have available to put down on the home. They will then match you with the appropriate loan program. They will provide you with an interest rate and closing cost estimates all documented on a Loan Estimate. They will also provide you with a preapproval letter, which you can use when you shop for a home.

The Underwriting Process

Even though you obtained a preapproval, it’s not a guarantee that you will get the loan. It’s a preliminary approval based on what you provide the lender at the time of application. Once you find a property and sign a contract, the lender will officially underwrite your loan and let you know if you are approved.

Chances are that your preapproval will still stand unless things drastically changed for you. It will also depend on the property that you are buying. Is it worth the value that you agree to pay? Is it in good enough condition to move into right away? Is it safe, sound, and sanitary? Your lender will order an appraisal in order to figure all of this out. The appraisal can take between one to two weeks depending on the appraiser’s workload and the seller’s availability.

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Taking Care of Conditions

Once the lender underwrites your loan, they may give you an ‘approval with conditions.’ This simply means that the lender needs more information from you. If you respond in a timely manner with the documents that they need, you can clear the conditions and move onto the closing.

For example, they may ask for an additional paystub or they may want an explanation on an account on your credit report. Your lender will let you know what they need. If you can provide adequate documentation that proves that you are still a good risk, your approval will still stand.

Locking Your Interest Rate

At some point during the process, after signing a contract, you will have to lock your interest rate. You must do this at least a few days before your scheduled closing. This ensures that the lender can prepare the right documents for you.

You can lock an interest rate for as little or long as you want. Typically, the longer that you lock the rate, the more it will cost you. In other words, the higher the interest rate you will get. Lenders take a risk when they lock in an interest rate for a long time, so they typically charge more in order to make up for that risk.

Closing the Loan

The final step is to close the loan. Don’t make the mistake of getting too comfortable at this point, though. The lender will still do one final check on your credit score and your employment. They want to know that nothing changed between the time that they preapproved you for the loan and the closing. If you applied for new credit, made large purchases, or quit your job, you could put your approval at risk.

If everything remains the same and the lender is ready to close on your loan, they will schedule a closing with the title company. You will attend the closing with a closing agent, the loan officer, and your attorney. Once you sign the documents, you are the proud owner of a new home and a new mortgage!

Getting through the mortgage process isn’t impossible – it is a lot of work, though. Understanding the steps ahead of time and how long you must wait for the process to complete can help take the stress out of the process.

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The Top 5 Tips for Shopping for a Mortgage

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As you shop for a mortgage, it’s easy to get overwhelmed. There are so many terms and numbers thrown around, not to mention the decisions you must make. Before you set out to get a mortgage, learn the top things you should know to make it a success.

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Know Your Credit Score and Credit History

Before you shop for a mortgage, you should be an educated borrower. That includes being educated about yourself. Do you know your credit score? Do you know what your credit history looks like? If not, now is the time to look.

You can get a free copy of your credit report from www.annualcreditreport.com. This will give you your credit history, not your score. Go over the report. Look for any inaccuracies. Do all of the accounts belong to you? Is all of the payment information correct? If anything is incorrect, address it with the reporting credit bureau and reporting creditor right away. It may take some time to get it fixed.

Also, look at your trade lines. Do you have late payments? Take the time to bring the accounts current. Do you have too much credit outstanding? Try to pay your balances down. The more you improve your credit history, the higher your credit score will get. If you want to know your actual credit score, check with your credit card companies or bank, they usually offer free access to your credit score.

Get Pre-Approved

All buyers, whether first-time buyers or not, should get pre-approved before shopping for a home. The pre-approval lets you know a few things:

  • How much loan you can borrow
  • The maximum purchase price you can afford
  • The loan program you qualify for
  • The loan’s terms

A pre-approval also helps when dealing with sellers. Many sellers won’t show you their home unless you are pre-approved. It’s the only way to know that you are a serious buyer. Without the pre-approval, you could be a nosy neighbor or someone that thinks they can buy a home, but may not be able to afford it.

We suggest getting quotes from at least three lenders when you get pre-approved. This way you have at least three loans to compare to one another and decide which one is right for you.

Know All of Your Options

Today you have many options when taking out a mortgage. Government-backed loans, such as FHA, VA, and USDA loans are all flexible options. You also have conventional loans, which have slightly stricter guidelines as well as subprime loans, which vary by lender.

Ask about all loans that you qualify for based on your credit score, down payment, and debt-to-income ratio. This way you can weigh all of your options. Government-backed loans typically have flexible guidelines and require little down payments (some don’t even require a down payment). You may pay a funding fee or annual mortgage insurance for the life of the loan, though.

If you have great credit, low debt ratios, and at least five percent to put down on the home, you may qualify for conventional financing. These loans don’t have a funding fee and only require Private Mortgage Insurance until you owe less than 80% of the home’s value.

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Knowing your options gives you a chance to determine which loan costs the least now, as well as over the life of the loan. Don’t just take the loan with the lowest interest rate – look at the big picture to decide which loan is right.

Don’t Take Out New Credit

The last thing you should do is apply for new accounts when you are ready to shop for a mortgage. Lenders look at your credit history, your current outstanding credit, and any current inquiries. They’ll know if you took out new credit. Even if you have a lot of inquiries, but no new credit, they’ll be hesitant to give you a loan.

A flurry of new inquiries means that you are desperate for money. If the inquiries are less than 60 days old, there could be new loans out there that aren’t reporting on the credit report yet. It’s best to keep your credit as stable as possible before taking out a mortgage. This is even true after you get pre-approved. Lenders will pull your credit again just before the closing. Avoid opening any new accounts, closing old accounts, or even using your current credit card accounts to keep your approval.

Think About the Future

Most people take the first loan that comes to mind – usually the 30-year fixed loan. What if you could afford more, though? What if you could pay your loan off in half the time? A 15-year fixed loan means you pay a lot less interest because you pay the loan off much faster.

Think about your goals. Do you plan to be debt-free before you retire? Plan your term around that time. Do you plan to go from one income to two or two to one in the future? This could also affect the size of the mortgage payment that you take. While you can refinance your mortgage in the future, it’s best to choose the mortgage now that will still work in the long run.

Shopping for a mortgage doesn’t have to be stressful. Set yourself up with the right mortgage the first time by educating yourself on the process. Go into the mortgage process knowing what you want and the best way to get it. This will give you the best outcome for one of the largest investments of your life.

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