Stated-Income

Are Tax Returns Needed to Refinance Your Mortgage?

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You know you have to verify your income in order to refinance your mortgage. Unless, of course, you qualify for the VA streamline or FHA streamline loan. You aren’t required to verify your income if you use a streamline program.

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But just what does it mean to verify your income? Do you need paystubs, W-2s, and tax returns?

There isn’t a straight answer to this question. It depends on the situation. Some borrowers will have to provide their tax returns, while others won’t need to provide them.

Salaried and Hourly Borrowers

Salaried and hourly borrowers typically don’t have to provide their tax returns when refinancing their mortgage. If you make a yearly salary and it stays the same all year, your lender won’t have a need for your tax returns. Your paystubs and W-2s will show the necessary information for the lender to qualify you for the loan.

Hourly employees are also exempt from providing their tax returns. Hourly employees will have to provide their paystubs covering the last 30 days and their W-2s covering the last 2 years. This way the lender can determine a 2-year average of your income. They do this in the event that your hours vary, which would give you varying income. Taking a 2-year average helps the lender account for the highs and lows that your income may experience.

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Borrowers Paid on Commission

If you work on commission and it makes up more than 25% of your income, you will need to provide your tax returns for the last 2 years. Lenders will look at your tax returns to see if you have any unreimbursed employee expenses that they must deduct from your income. They will also look for any deductions that you take that are work-related. Lenders are required to use your adjusted gross income as it is reported on your tax returns. If you claim many deductions, it could affect your ability to secure a mortgage.

Self-Employed Borrowers

Finally, we have self-employed borrowers. These borrowers definitely need to provide the last two years of their tax returns. Just like borrowers paid on commission, lenders need to determine the adjusted gross income of the self-employed borrower.

Because the lender will use your AGI as reported on your tax returns, it works to your benefit to avoid taking too many deductions during the 2 years leading up to your loan application. Even though this will increase your tax liability temporarily, it will also increase your chances of securing a mortgage.

Don’t worry if your lender asks for your tax returns. It’s just another way for them to verify your income. As long as your tax returns are legitimate and they reflect what your paystubs and/or W-2s already show, you are in good hands. The lender will use your tax returns to calculate your gross monthly income, which they then use to determine your debt ratio. This is the lender’s way of determining if you can afford the loan and if you are a high risk of default.

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Do you Really Need a 20% Down Payment to Purchase a Home?

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Do you believe that you need 20% to put down on a home before you can get a mortgage? You aren’t alone, but you are incorrect. There are several loan programs, including a conventional loan, that allows you to buy a home with much less than 20% down on it.

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While it’s true that you need 20% down on a home if you want to avoid paying Private Mortgage Insurance, you can certainly get a loan without that large down payment. In fact, in some cases, it’s wise to avoid making the large down payment. If you don’t have an emergency fund, saving the money in a liquid savings account may be a wiser choice for you in the first place.

Ways to Buy a Home Without 20% Down

So, what are the ways that you can buy a home with less than 20% down? We list them below.

  • Conventional loans – Many conventional lenders require just 5% of the purchase price of the home to get conventional financing. With this low down payment, you will pay Private Mortgage Insurance, which can add between $30 – $150 to your payment depending on the size of your mortgage.
  • FHA loans – You only need 3.5% down on an FHA loan. You don’t need to be a first-time homebuyer as many people believe to secure this loan either. Anyone with a credit score of at least 580, debt ratios around 31/43, and stable employment may qualify. The FHA also allows borrowers to receive 100% of the down payment as gift funds. All FHA borrowers pay Mortgage Insurance for the life of the loan. Right now, borrowers pay 0.85% of the average outstanding principal balance of the loan.
  • VA loans – If you are a veteran that served at least 90 days during wartime or 181 days during peacetime, you may secure 100% financing for the purchase of a home. This means no money down on a home with a flexible financing program. The VA loan doesn’t require any type of mortgage insurance either. You just pay an upfront funding fee to the VA.
  • USDA loans – If you prefer rural living to city life, you may benefit from the USDA program. This loan also provides 100% financing. In order to qualify, your total household income must not exceed 115% of the average income for the area. The USDA does charge annual mortgage insurance, but it’s only 0.35% of the outstanding loan amount.

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What’s the Benefit of a 20% Down Payment?

If there are so many programs that allow you to put down less than 20% on a home, why would you want to put 20% down? There are a few simple reasons.

  • You may have an easier time securing a mortgage approval. The more of your own money that you have invested in a home, the more likely a lender is to approve you for it. The higher down payment can offset a low credit score or high debt ratio, both of which are often risk factors that make lenders turn applicants down.
  • You may get a lower interest rate. The more money you invest in a home, the less risk the lender takes. Because lenders choose interest rates based on the risk that you pose, you may be able to secure that low interest rate you wanted for your mortgage.
  • You’ll have a smaller mortgage payment. The less money you borrow, the smaller your payment becomes. Who wouldn’t want a smaller monthly payment? You won’t’ have to worry about mortgage insurance. Your payment will be principal, interest, real estate taxes, and homeowner’s insurance.
  • You’ll build equity in the home faster. The first few years that you make mortgage payments, you will pay mostly interest on your payments. This means you touch the principal balance very little. This means you gain very little equity in the home. If you make a large down payment, though, you’ll have instant equity in the home.

Keep in mind, though, as we talked about above, it doesn’t always make sense to make the large down payment. If it is going to put you in a financial bind, you are better off keeping the money in a liquid account for financial emergencies.

It also may not make sense to put a lot of money down if you don’t plan to stay in the home for the long-term. If you know you will move in a few years, you won’t pay a lot of interest on the money you borrow, which allows you to keep your money liquid for the purchase of your next home when you do move.

Whether or not it makes sense for you to put 20% down on a home depends on your situation. Talk to a few lenders and get quotes for a variety of situations with and without a 20% down payment. This will help you decide which program would work the best for you.

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How Many Months of Payslips do you Need to Get a Mortgage?

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One major factor in your ability to secure a mortgage is your income. You must show lenders that you can afford the mortgage as well as your other monthly debts and still have money left at the end of the month. Lenders need to make sure beyond a reasonable doubt that you can afford the mortgage before they can allow you to sign on the dotted line.

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Just how do you prove your income? It depends on the type that you earn. For example, if you work on commission and it totals more than 25% of your total income, the lender will need your tax returns. If your income is just a base salary or is made up of less than 25% commission and/or bonuses payslips will work.

Covering 30 Days

Your payslips must cover at least the last 30 days. Lenders use these documents to make sure your income adds up to what you say you make. It’s not enough to say that you make $60,000 per year. You have to prove it. Even if you provide your tax returns for other purposes, you must show lenders that your year-to-date income is on par with what your tax returns show.

Because you only need to cover the last 30 days, the number of payslips you must provide will vary based on your pay schedule:

  • Weekly pay – You must provide the last four paystubs
  • Bi-weekly pay – You must provide the last two paystubs
  • Monthly pay – You must provide the last paystub you received

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Paystubs Before the Closing

Some lenders may also make you provide a paystub right before the closing. This reconfirms the fact that you are still employed. This is common practice when a lot of time passes between the application and the closing. If it’s a matter of a few months, lenders must confirm that you are still employed. Some lenders just conduct a verbal verification of employment, but others may require another payslip.

The Other Income Documents

Your payslips aren’t the only income documentation lenders will require. Along with seeing your current income, they also need proof of your past income. If you make a base salary or don’t work on commission, you can provide your last two years of W-2s. These documents will show lenders your salary over the last two years.

If you work on commission or bonuses, the lender may request your W-2s a well as your tax returns. This gives them a chance to determine if you have any unreimbursed expenses that coincide with your employment. If so, the lender will deduct those expenses from your income for qualifying purposes.

This is all in addition to your paystubs. Lenders use the W-2s or tax returns to see your pattern of income. They want to make sure your income either stayed stable or increased over the last 2 years. The payslips will then confirm that you are on the same path this year as your W-2s or tax returns show.

The lender will likely ask for your payslips when they pre-approve you for a loan. They look at paystubs first and then ask for further documentation if necessary. Have your payslips ready when you know you want to apply for a loan so that you can get the process right away.

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How Much of Your Monthly Income Should be Spent on a Mortgage?

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Knowing how much mortgage you can afford is one of the most important steps you can take before buying a home. Getting in over your head can cause buyer’s remorse and worse yet, financial troubles. Before you let that happen to you, learn how much of your monthly income you should spend on your mortgage.

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Understanding Gross and Net Income

First, you should know that lenders look at your gross income when qualifying you for a mortgage. This is not your take home pay. In other words, this isn’t the money you see in your bank account. It’s the money you make before taxes and other deductions. If you are being realistic with yourself, you should base how much mortgage you can afford on your net income. This may mean that you take a mortgage that is less than a lender approves you for and that’s okay.

Using the Conventional Guidelines

We prefer to use the conventional guidelines to determine how much mortgage you can afford. While conventional guidelines are a bit more conservative than any other loan program, they help you stay in control of your finances.

According to conventional loan guidelines, your housing payment shouldn’t exceed more than 28% of your gross monthly income. Here’s an example.

Let’s say you make $75,000 per year. Your gross monthly income is $6,250. If you take 28% of that amount, you’d have a mortgage payment equal to $1,750. If your take home pay is 85% of your gross pay, the mortgage payment would actually be 33% of your take home pay. This is why we prefer the conventional loan guidelines as it keeps your mortgage payment as a small portion of your income.

The Total Mortgage Payment

It’s important to understand what goes into the total mortgage payment. When a lender tells you how much mortgage you can afford, the payment will include:

  • Principal
  • Interest
  • Real estate taxes
  • Homeowner’s insurance
  • Mortgage insurance (if applicable)

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The $1,750 we discussed above doesn’t mean all principal and interest. You would have to take out 1/12th of the annual real estate taxes, homeowner’s insurance, and mortgage insurance, if necessary. What is left will cover the principal and interest.

Your Total Debt Ratio

Lenders also look at your total debt ratio. This is the total of all debts compared to your gross monthly income. You don’t have to include debts like utilities, school tuition, or insurance payments. It’s only the payments that are included on your credit report. The most common include:

  • Credit card minimum payments
  • Installment loans
  • Car loans
  • Student loans

A good rule of thumb is to keep your total debt ratio at 40% of your gross monthly income. If you use conventional or government-backed mortgage programs, your absolute maximum debt ratio allowed will be 43% according to the new mortgage guidelines.

If you don’t have a lot of ‘other debts,’ you may have a little more leeway in your mortgage payment. Lenders might be a little more flexible, allowing your housing ratio to hit 30% or so. This will vary by lender, though.

Only you know how much money you are comfortable spending on your mortgage. Don’t take the allowed amount from a lender at face value. Do your homework and figure out what payment will comfortably fit within your budget. Remember, your mortgage is something you may have for the next 30 years. Think about what you planned for your future. Will you have children? Will you go down to a one-income household? These factors will play a role in how much mortgage you should take on to keep it affordable.

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What to Do if You’re Rejected for a Home Loan

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Applying for and being rejected for a home loan isn’t a good feeling, but it doesn’t have to be the end of the road for your potential home-ownership. If you take the right steps, you can try again in the near future.

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Follow these steps if you find yourself in this situation.

Get Information

If a bank or lender turns you down for a loan, they have to give you a reason. If you don’t understand the reason provided, ask for more specifics. If it has anything to do with your credit, they have to send you a letter stating the reasons for the denial. If it was to do with anything besides your credit, most loan officers will happily walk you through the reasons that you were denied.

Once you have the reasons, it’s time to take action. You are armed with information on what is wrong with your application, now you can take the steps to fix those issues.

Fix Your Credit for Your Home Loan Application

Did your loan officer tell you that your credit was the issue? Following are the most common credit issues:

  • Low credit score – If your credit score is too low, it’s time to pull your credit report and found out why. The letter your lender sends you will explain how you can receive a free copy of your credit report because you were turned down for a home loan due to a credit issue. Get a copy of your report and look for the reason for the low credit score. Was it late payments? Did you charge too much on your credit cards? Do you have too many inquiries?
  • Not enough credit – If you only have a few trade lines and they aren’t currently active, a lender may not be able to make a lending decision. You’ll need to build your credit up by applying for a few credit cards and using them. Don’t take this as permission to go out and go on a spending spree, though. Instead, charge what you normally purchase and pay cash for, then pay the bill off in full each month. This will establish good spending patterns and help you build up your credit.
  • Too many inquiries – Inquiries are a red flag for lenders because they could indicate that you have new credit out there that hasn’t reported yet. You may just have to wait it out a few months to prove that you don’t have any new credit lines (if you don’t) or let the new credit lines report on your credit report for the lender to get an accurate credit score and debt ratio calculation.
  • Negative economic events – If you recently had a bankruptcy or foreclosure, you may not have let enough time pass. Each loan program has a specific waiting period. Ask the lender how long you need to wait. In the meantime, keep improving your credit score to enhance your chances of approval the next time you apply.

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Deal With Low Income

If the lender decided you don’t make enough money, they could turn down your application. While you might think there’s no way to fix this issue, there are a few simple ways.

  • Take a side gig – Do you have a skill that you could turn into a side job? Whether you offer physical services, such as electrician work, plumbing, or painting or you do something on the internet, such as writing, crafting, or a virtual assistant, there are many ways to make money on the side. You’ll have to have the job for at least 2 years before you can use the income for qualification purposes. If that’s too long, you can use the extra money to pay down your debts and lower your debt ratio to help your chances of approval sooner.
  • Get a cosigner – If you have a willing cosigner that has good credit, they can help you get approved for a home loan. Make sure it’s someone that is willing to take the obligation of paying the mortgage should you stop paying it. This is a large risk on the cosigner’s part, so make sure there is a clear understanding between both of you.

Deal With Your Debts

Did the lender tell you that you are straddled with too many debts? It’s time to work on them before you apply for another mortgage.

  • Pay the debts down – It’s time to set up a strict budget to get your debts paid down. If you don’t have extra money lying around, take a second job or side gig to boost your income. Then use that extra money to pay your debts down.
  • Apply for a lesser loan amount – If it was the housing ratio that was the issue, it might be time to look for a less expensive home. If your credit score was fine and your income is stable, consider a lower sales price, which means a lower monthly payment.

Increase Your Down Payment on the Home Loan

Sometimes it’s just about the amount of collateral you give the lender. If you borrow a large percentage of the sales price, the lender may see it as too high of a risk. Increasing your down payment can minimize that risk. This could take time though, since you’ll have to save money. Using some of the above strategies, such as paying down your debt or taking on extra work can help you save money faster. In some cases, you may even be able to secure gift money for the down payment from family or your employer. Most loan programs allow the use of gift funds to help boost the equity you have in the home and the collateral the bank has to rely on if you default.

Getting turned down for a home loan isn’t fun, but there are ways to overcome it. Use these tips to improve your chances of approval and get the loan that you want to buy your next home.

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What are the Fannie Mae Self-Employed Income Guidelines?

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If you are self-employed, you might wonder what type of mortgage you will be eligible to obtain. Do conventional loans even exist for the self-employed borrower?

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Luckily, they do exist. Fannie Mae has guidelines that make it flexible for those that work for themselves to secure a mortgage without having to pay subprime interest rates and/or fees.

Keep reading to learn the guidelines for this conventional loan program below.

The Basic Guidelines

Any borrower that makes more than 25% of their income from self-employment must disclose the type of business and its location. They must also demonstrate a demand for the product or service that they offer as well as show the financial stability of the business. Finally, Fannie Mae requires that the business prove that they have the capital and ability to generate future income with the business.

In order for the lender to be able to consider your self-employment income, you must have a 2-year history of receipt. If you don’t have a 2-year history, you may still be able to qualify for the loan if you are able to prove that you have experience in the industry. For example, if you left your job as an accountant to open your own accounting service, you can prove that you have the expertise to make the business work.

Typically, a lender will need to make sure that your income from the business is in line with the income you received when you were employed. In other words, if there is a drastic decrease in income on your tax returns, a lender may not be able to use it. But, if it’s close to the income you made as an employee, a lender may use it.

Verifying Your Self-Employment Income

The tricky part is verifying your self-employment income. Fannie Mae has strict guidelines regarding how you can verify it. The lender needs to be able to prove beyond a reasonable doubt that you can afford the loan.

This means verifying your income with the following:

  • All schedules of your tax returns over the last 2 years
  • Copies of your IRS transcripts for the last 2 years
  • Copies of your business tax returns unless you meet the exceptions below

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You don’t need to provide your business tax returns if you meet the following requirements:

  • You are using your own personal funds for the closing costs and down payment and not funds from the business
  • You have owned your own business for at least 5 years
  • Your personal income tax returns show increasing income over the last 2 years

The Lender’s Evaluation

Once you provide all of the necessary documentation, the lender must determine if your personal and/or business income is adequate. The lender will evaluate your personal tax returns and look at your business income or loss. This will give the lender the best idea of the cash flow you have and whether you can afford a mortgage.

The only exception to this rule is if your self-employment income isn’t your main income. For example, if you work a salaried job, but have a side hustle that you run yourself, the lender doesn’t have to evaluate your self-employment income as thoroughly as they would if it was your main income.

If the borrower doesn’t meet the requirements to waive the need for business tax returns, you will also have to supply two years of your business returns. The lender will evaluate these tax returns as they compare to other businesses in the same industry. They look for consistency and reliability to ensure that the business will continue moving forward and provide you with the necessary income for a mortgage.

Even though Fannie Mae requirements are usually much stricter than other loan programs, their self-employment requirements aren’t that strict. As long as you can prove that your income is consistent and stable, there’s a good chance you can use it for qualifying purposes on a conventional loan.

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Understanding the Different Types of Mortgage Loans

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Applying for a mortgage loan can be overwhelming. As lenders throw different terms at you, it’s easy for you to get confused. Before you even shop for a mortgage, you should know the type of loans available so that you can make the right choice for you before you even shop for a home.

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Below we discuss the various options available for you to learn the options that may be available to you.

Conventional Loans, Government-Backed Loans, and Subprime Loans

First, let’s consider the type of mortgage you should consider. The most common options are conventional and government-backed loans. If you don’t meet the requirements of either type of these loans, you can opt for a subprime loan.

Conventional loans are loans sold to Fannie Mae and Freddie Mac. They are your ‘general loans,’ that most lenders offer. Typically, you have to have good credit, low debt ratios, and a decent down payment to qualify for this program. In other words, the requirements are the toughest for these programs.

You’ll need at least a 5% down payment for these loans. If you do opt to put down less than 20% on the home, expect to pay Private Mortgage Insurance until you owe less than 80% of the home’s value. If you do put less than 20% down on the home, lenders tend to be a little more cautious about your credit scores and debt ratios, as you pose a higher risk with a higher LTV.

Government-backed loans are those backed by a government agency. The options include FHA, VA, and USDA loans.

  • FHA loans – FHA loans are backed by the Federal Housing Authority. With a 580 credit score, 31% housing ratio, 43% total debt ratio, and 3.5% down on the home, you may be a good candidate for this program. You don’t have to be a first-time homebuyer to secure this loan program, as many people believe. Note that you will pay an upfront mortgage insurance premium plus mortgage insurance for the life of the loan, no matter your LTV.
  • VA loans – Veterans that served at least 90 days during wartime and 181 days during peacetime may be eligible for a VA loan as long as they had an honorable discharge. This loan program doesn’t require a down payment. It also has flexible underwriting guidelines, allowing credit scores as low as 620 and debt ratios as high as 43%. The largest qualifying factor is the need to meet the VA’s disposable income requirements based on your location and family size. You will not pay any mortgage insurance for this loan.
  • USDA loans – Low to moderate-income families that don’t qualify for any other mortgage program may qualify for the USDA loan. The catch is that you have to buy a home in a rural area. The USDA is liberal with their rural boundaries, though. The USDA requires a 640 credit score; 29% housing ratio, and 41% total debt ratio. You will pay an upfront mortgage insurance fee as well as annual insurance for the life of the USDA loan.

Subprime loans are those that don’t fit in the conventional or government-backed loan programs. These loans are provided and held by private lenders. They don’t sell them on the secondary market. This allows the lender to set their own requirements, which may provide you with more options for qualifying. For example, some lenders allow the use of bank statements rather than tax returns for self-employed borrowers. This gives self-employed borrowers a greater chance of qualifying for the loan. Subprime lenders may also allow lower credit scores, higher debt ratios, or make other exceptions that conventional and government-backed lenders cannot provide.

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Jumbo Loans

Finally, if you need a loan amount that exceeds the standard conforming limit, you will need a jumbo loan. This year, these loans exceed $453,100. These loans usually have stricter guidelines than even conventional loans require because of the higher risk of the high loan amount.

You should expect to need a great credit score, low debt ratio, and a large down payment. The requirements will vary by lender, though, so make sure you shop around.

Fixed Rate and Adjustable Rate Loans

Once you determine the type of loan you need/want, you’ll need to look at the type of interest rate you can choose. You’ll hear lenders talk about fixed interest rates and adjustable interest rates.

Fixed interest rates are fixed for the life of the loan. The rate you get at the closing is the rate you keep as long as you keep the loan. It doesn’t matter what happens in the market – your rate never changes. You can usually opt for a fixed rate between 15 and 30 years, but the exact term depends on your qualifying factors and what the lender offers.

Fixed interest rates offer predictability. They never change, so you can always budget for your payment. The downside, though, is if you take the mortgage during a period of higher interest rates, you are stuck with that rate for the life of the loan.

Adjustable rate loans are fixed for a short period and then they adjust, usually on an annual basis. You can usually lock in the ‘introductory rate’ for 3 to 10 years. After that point, the rate is based on the chosen market index of the lender plus the predetermined margin.

The benefit of the ARM loan is the lower interest rate you get for the first few years. This rate is usually lower than the fixed interest rates at the time, allowing you to save money on interest for a few years. The downside is that you cannot predict what interest rates will do in the future, so you don’t know what your payment will be in the future.

Choosing the right loan program is important as it will determine your ability to qualify for the loan as well as afford the payments. Make sure you exhaust all of your loan options and compare them side-by-side so that you can determine the best option for you.

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Is Gross Income Before or After Taxes?

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When you apply for a mortgage, your lender will ask about your gross income. You might be surprised to learn that this isn’t the money you bring home on your paycheck. It’s the full amount of your income before taxes and other deductions.

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Keep reading to learn why lenders use this number and which number you should use for your own budget.

Why Lenders Use Gross Income

The main reason lenders rely on your gross income rather than the net income is its reliability. Your net income is your total salary minus taxes and other deductions. These deductions could change often, so using your net income might give lenders inconsistent results. For example, if your company changes insurance plans or you change your tax filing status, your net income may change. Even if it’s only a $100 difference, it may still alter your ability to secure a loan.

Another reason lenders use gross income is that it’s a number you likely know off the top of your head. If someone asks you how much money you make per year, you probably know the salary your employer pays you better than the amount of your paycheck and how it converts into your annual salary. For example, it’s much easier to rattle off $75,000 per year rather than figuring out how your $5,267 monthly check converts into an annual salary.

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How Lenders Use Your Gross Income

Lenders use your gross income to determine the maximum amount of your loan payment. Each loan program is different, but as a general rule, you can use the conventional loan guidelines of 28% and 36%. In other words, you can have a mortgage payment that is up to 28% of your gross monthly income. But lenders will also look at your total debt ratio. This is the total of all of your monthly debts including your mortgage payment – this figure shouldn’t exceed 36% of your gross monthly income.

Why You Should Focus on Net Income

Now just because a lender focuses on your gross income doesn’t mean you should use this figure. Your net income is the money you actually take home. This is the money you can use to pay your bills. You want to make sure that the mortgage payment you take on fits into that budget.

A good way to figure it out is to put the potential mortgage payment into your monthly budget. Are you comfortable with the payment? Do you have enough money left over after paying your bills to cover your living expenses?

If you focused on your gross monthly income, you might take on a mortgage payment that exceeds what you bring in or what you can comfortably afford. Some people don’t want to take on debts that eat into their disposable income. Many borrowers don’t want to live paycheck-to-paycheck. These are all reasons why you should focus on the net income to make sure you are taking on a loan you can afford.

Your lender will focus on your gross income, so make sure you have those numbers handy when you apply for a loan. But when you think about what you can afford, your net income is a better figure to consider to ensure that you only take on what you can afford.

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Do You Get Instant Equity When Buying a Distressed Property?

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Buying a distressed property can save you a lot of money. Foreclosures and short sales are the most common types of distressed homes available. The term distressed makes them seem as if they are run down. They don’t have to be, though. In fact, they may be in great condition, giving you instant equity in the home.

How Does Instant Equity Work?

Usually, when a home sells as a foreclosure or short sale, you pay less than the home is worth. In these cases, the bank is just interested in making their money back that they lost on the loan. The bank will sell the home for around the amount owed. This may be significantly less than the value of the home. The difference between what you pay and the value of the home is your equity.

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Some buyers turn around and sell the home right away. They make an instant profit on their investment because they can sell the home for more money. Others keep the home and do work to it. Their hope is that they will make even more on the sale of the home. Yet some buyers keep the property and rent it out.

What Type of Distressed Property Can You Buy?

Short sales are among the most common distressed properties. They are homes that the owner is upside down on the home. The owner wants to sell the home, but there isn’t enough value in the home to pay off the loan. Their lender agreed to accept the lower amount for the home. No seller can offer this agreement without getting lender approval first. In many cases, the home is in fine condition, it was just a casualty of a declining market.

Foreclosures are another common distressed property. In this case, the owner could not keep up with his mortgage payments. The home is no longer owned by the homeowner. The bank is the new owner. The bank now wants to get rid of the home. Oftentimes, these homes are in poor condition, but not always. Some homeowners take their frustration at losing their home out on it by causing damage or neglecting to take care of it.

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Pre-foreclosure sales are less common, but still exist. Owners of these homes are 90-days past due on their mortgage. The bank has likely started foreclosure proceedings, but they have not gone completely through yet. Getting a good deal on this home is likely and there is usually less competition for the home since fewer people know about it.

Creating Equity in a Distressed Property

Even if you do not get instant equity in a distressed property purchase, it doesn’t mean you can’t make it. If you buy a home that needs extensive work, chances are the value will increase after your work is done. Before you start making changes, consult with a professional. Find out which renovations will give you the greatest return on your investment. Don’t make the mistake of assuming every renovation will give you a dollar for dollar return on your investment. Many changes don’t impact the value much at all.

Talk to an appraiser or real estate professional. Let them tell you what changes will help you earn the equity you want. Even though it might not be instant equity, you’ll receive it soon enough after the changes are made.

Buying a distressed property can result in quite a profit right away or shortly down the road. You’ll have to do your homework regarding the right properties to buy, though. Not every property will give you a great return on your investment. Research the home itself as well as the surrounding area so you know what to expect from the investment.

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