Stated-Income

Reserves and Mortgages: How Much Do You Need to Qualify for a Loan?

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What happens after closing? You start making your mortgage payments, pay your property charges, and so on. Do you have enough funds to cover these expenses in case something unexpected happens? These “leftover funds” are called financial reserves.

Lenders will look into these funds to determine if you have enough set aside before they approve your mortgage. As to the minimum level of reserves required, that will depend primarily on your loan type, property, and borrower profile.

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What Are Reserves?

Reserves are assets that are available to you post-mortgage closing. By available, these assets must be readily convertible to cash for your use, per Fannie Mae, who together with Freddie Mac, is the largest purchaser of mortgages in the secondary market.

To make them more relatable, think of these funds as x months’ worth of your total housing expenses as represented by PITI or PITIA:

  • Principal
  • Interest
  • Taxes
  • Insurance (homeowners insurance, mortgage insurance)
  • Homeowners association dues, other assessments

While they are not as popularly discussed as down payment and closing costs, reserves are an important aspect of your mortgage that you should prepare for, save up if you must.

Eligible or Not Eligible Assets for Reserves

Not all assets are eligible to be considered as reserves. Aside from being liquid assets, they must be redeemed/vested, taken from personal bank accounts, or derived from the sale of an asset.

Aside from cash, these are acceptable sources of reserve funds:

(i) savings/checking accounts, (ii) stocks, bonds, certificates of deposits, trust accounts, or any investments, (iii) the portion of the retirement savings account that has vested, and (iv) the cash value of a vested life insurance policy.

As to retirement accounts, not all of the whole vested amount will be considered, e.g. 70% of 401(k), IRA and other related accounts’ vested value.

Stock units become unacceptable if they are from a company or corporation not listed with the SEC. This applies to stock options and restricted stock units that have not vested.

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You can’t also use personal unsecured loans or proceeds from cash-out refinance for your reserve funds.

This is why lenders verify assets for reserve requirements (although this asset verification applies to down payment and closing costs) to ensure that the borrower has funds safely tucked in and that these funds are not illegally sourced or additionally burdensome to the borrower.

How Much Do You Need for Your Reserves?

Your minimum reserve requirement rests on a combination of various factors. But a good starting point would be the property type, i.e. its occupancy status and the number of units.

From there, you can look up what each loan type’s reserve requirement is:

  • FHA loans: This loan program does not have a reserve requirement on one-to-two properties. But for borrowers with non-traditional credit or those requiring manual underwriting, one month of reserves is required. On three-to-four unit properties, reserves worth three months of PITI are required.
  • VA loans: Just like FHA loans, these loans for military personnel require (i) no reserves on one-to-two unit properties and (ii) six months’ reserves on three-to-four unit properties. The borrower also pays additional three months of reserves for every rental property he or she owns.
  • USDA loans: Although these government-guaranteed loans don’t really require cash reserves after closing, having two months of reserves can be a compensating factor.
  • Conforming Loans: The reserve requirements for Fannie Mae take into account the transaction type, the property’s number of units, the borrower’s credit score and LTV, and debt-to-income ratio, the type of underwriting (DU or manual). This is an example of Freddie Mac’s reserve requirements matrix.
  • Jumbo Loans: Reserves on those loans can be equal to three months, although they can go higher depending on the size of the loan.

Indeed, buying a home goes beyond closing. There’s your house to take care of after the transaction closes. Despite reserves being a requirement, it’s wise to have funds set aside for your home.

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Jumbo Loans Get Redefined as Conforming Loan Limits Increase in 2018

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Jumbo loans just got bigger. Beginning 2018, the conforming loan limit on a one-unit home in most parts of the U.S. will increase to $453,100 from $424,100. In high-cost counties, the standard loan limit will also increase to $679,650.

Those borrowing money higher than the standard conforming loan limits belong to the jumbo loan club. Qualifying for jumbo loans is tougher than on traditional loans because of inherent market risks and individual lender standards.

Do you qualify for a jumbo loan? Ask a lender today.

Conforming Loan Limits Boost Jumbo Loans

The Federal Housing Finance Agency who regulates Fannie Mae and Freddie Mac has raised the conforming loan limits to reflect a 6.8% increase of home prices in the U.S. based on the seasonally-adjusted expanded-data House Price Index (HPI).

Consequently, the 2018 conforming loan limit is $453,100 and it can reach $679,650 at most to account for one-unit homes in expensive counties in the U.S.

A list of 2018 conforming loan limits is accessible here.

Fannie Mae and Freddie Mac purchase loans within those loan limits, thereby known as conforming loans. The GSE loan limits also affect other government loan programs.

For example, VA loans match GSE loan limits to calculate the amount of VA guaranty. FHA loan limits in high-cost areas are based on Fannie/Freddie loan limits.

Because jumbo loans fall outside of standards set by the GSEs and relevant government agencies, they are underwritten by individual lenders.

Qualifying for Jumbo Loans

The territory of jumbo loans is vast. These loans for bigger homes for property flippers, investors and more are offered at varying terms and conditions.

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In terms of process, applying for a jumbo loan is no different from the usual standard loan because lenders will still weigh these qualifications:

  • Credit scores on jumbo loans may be higher or at par with conforming loans. There might be some wiggle room for borrowers with less-than-perfect scores but they’ll get higher rates than those with excellent credit.
  • Debt-to-income ratio is ideally 43% and below. But ample cash reserves of at least six to 12 months can possibly make up for an above 43% DTI or a low credit score for that matter.
  • Down payments are usually higher on jumbo loans. They can be at least 10% up to 30% of the purchase price, depending on the lender.

Documenting income is tricky for self-employed borrowers taking out traditional loans. For jumbo loans, lenders might require just one year of tax returns filed with the IRS to document income from a stable or growing business.

To be fair, Fannie Mae has eased its guidelines in documenting self-employment income, requiring only one year of filed tax returns to qualify for a conforming loan.

Rates on jumbo loans are higher than on conforming loans because they carry the risk of not being eligible for purchase by Fannie Mae or Freddie Mac.

If you’re buying a home in a high-cost area, your loan might still be within conforming standards. Ask lenders about this and other loan matters.

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How Latest Tools, Eased Rules in Appraisals Benefit Mortgage Borrowers

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Tablet

In October, at least three new tools that would improve how appraisals are being done were introduced to the market. Add to that the more relaxed guidelines like property inspection waivers by Fannie Mae and Freddie Mac, relying less on human appraisers.

The easing of rules and more automation could mean a less costly and better mortgage experience for borrowers. Valuations or appraisals on homes remain a key ingredient in making loans. They ensure that homes are not overvalued or undervalued – a scenario risky for both borrowers and lenders.

Learn more about these recent developments. Let’s help you find a lender, too.

More Tools to Improve the Appraisal Process

These companies that provide real estate insights and analytics and dabble into mortgage finance unveiled their respective products that aim to enhance the way appraisals are made.

  1. CoreLogic’s Appraisal Xcelerator – a digital tool that streamlines the process of scheduling appraisals among the lender, borrower, real estate agent, and appraiser. This technology, according to one company executive, will shorten the scheduling interaction among the parties above, thus reducing turnaround times and enhance overall customer experience.
  2. First American’s Smart Valuations – an offering that banks on reducing turnaround times by 16% to 20%, improve quality and cost-efficiency of appraisals as well. In propping up the product, the company points to larger housing markets where appraisals could take months to finish.
  3. HouseCanary’s Agile Appraisal™ – a product for residential appraisers, it mainly cuts the time needed to make standardized and reliable appraisals to five days. Through its regression technology, appraisers can address issues, e.g. property, location, time characteristics for a faster and more accurate appraisal.

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No Appraisals From Fannie and Freddie

Fannie Mae and Freddie Mac have gradually introduced changes to their mortgage guidelines. One significant enhancement is waiving property appraisals on certain loan transactions.

Under Desktop Underwriter® 10.1, Fannie Mae is offering property inspection waivers, as expanded, on purchase (primary and second homes up to 80% LTV) and refinance (limited cash-out, cash-out) transactions.

Particularly, an appraisal may be waived on such transactions if the subject property has a prior appraisal that can be pulled from Fannie Mae’s property database. In case of refinance loans, the prior appraisal must be associated with at least one borrower of the loan to be refinanced.

Freddie Mac did follow Fannie Mae’s appraisal waivers. On its version, a loan can be considered without an appraisal if it’s a purchase or no cash-out refinance.

The loan must secure a single-family one-unit property that is either owner-occupied or second home with a total LTV of less than or equal to 80%.

The decision of Fannie and Freddie to veer away from appraisals is a welcome development for borrowers of conventional loans conforming to their standards.

While the appraisal waivers don’t apply to all loans, at least, some mortgage borrowers get relief from paying related fees and waiting for property valuations to finish for their loans to close.

As new technologies are unfolding and guidelines are loosening, it’s only a matter of time before lenders become creative with mortgage products that cater to all sorts of borrowers, stated income loans included.

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Fannie Mae Tax Transcripts Requirements

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Fannie Mae Tax Transcripts Requirements

Tax transcripts are official transcripts obtained from the IRS. The use of these transcripts is to verify that the tax returns you provide to a lender are legitimate and not altered in any way. There are certain situations when the transcripts are required and also certain situations when the lender does not have to execute the IRS Form 4506, but may choose to do so in order to satisfy their own requirements since it is their right to add their own overlays onto the standard Fannie Mae requirements.

When are Tax Transcripts Required?

Tax transcripts are necessary whenever you need to provide your tax returns to qualify your income for a mortgage. This includes borrowers that are self-employed, work on commission, or get a great deal of overtime in addition to their regular salary. If you want this type of income included in your qualifying income, tax returns are necessary in order to qualify. If you must provide full tax returns, Fannie Mae requires that the lender verify those tax returns with the IRS. Form 4506 helps the lender obtain a transcript and compare it with the tax returns you provided to them at the time of application for the loan. If the amounts match, the loan can close as planned. If the amounts do not match, however, further verification will be necessary. Following are the circumstances that would warrant a lender to ask for your tax returns:

  • Commission income that totals more than 25% of your regular income
  • Income you receive from a family member that is also your employer (family owned business)
  • Income from a rental property if you use it for qualification purposes
  • Seasonal income
  • 1099 income
  • Interest income
  • Self-employment income that totals more than 25% of your income
  • K-1 income

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When are Tax Transcripts not Required?

Not every self-employment or commission situation will require tax returns or tax transcripts. The basic rule is that this type of income must make up at least 25% of your income in order for tax returns to be required. For example, if you work overtime, but the income does not equal 25% of your regular income, it can be verified with your paystubs and W-2s alone. The same is true for self-employment income that you may have on the side or commission income that your employer pays you. Other types of income that do not require tax returns or tax transcripts include:

  • Social security income
  • Military income
  • Disability income

Any of these types of income can be verified using W-2s and paystubs or a letter from the party providing the income on their letterhead along with bank statements to show receipt of the income.

Not a Pre-Closing Concern

Form 4506 must be executed, but it is typically not a condition to close the loan, unless there is reason to suspect that the borrower’s tax returns are not legitimate. Every lender can use their own judgment when it comes to determining if a borrower is legitimate or not. If the income is determined as legitimate, the lender is required to execute the 4506 at closing. In addition, you sign a document at closing stating that everything is accurate and true that you provided on your application.

What do Lenders Look at Tax Returns For?

You might wonder why lenders require tax returns in the first place. It makes sense if you do not have paystubs or W-2s to document your income, but what about the cases where you do have those documents, such as commission income or overtime income? Why is there the double requirement to verify your income? The answer is simple – the lender needs to determine if there are any unreimbursed expenses that you pay in order to hold that job. Fi there are such expenses, they must be deducted from your income and/or included in your monthly debt ratio.

This requirement is only put in place when you have self-employment, commission, or overtime income that exceeds 25% of your income. If this income does not exceed that amount, the expenses are not required to be included in your debt ratio or deducted from your income. In most cases, if you have self-employment on the side or you work on commission but only slightly, the debts you incur will report on your credit report, enabling the lender to include it in your debt ratio anyways.

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Rental Income

Not all rental income situations require you to provide tax returns and tax transcripts. If you obtained the rental property after completing your most recent tax return, it will not report on there, but you are still eligible to apply for a mortgage. In these cases, you simply must report the rental on your mortgage application, along with any loss or profit you make in regards to the property. The lender will likely be able to figure out the debts you incur for this property based on your credit report, helping the lender make a sound decision when it comes to your loan application.

Tax transcripts can take a while to come into the lender, so if you know the lender will require them, ask for the forms to be executed as early as possible. In most cases, lenders wait until the closing to execute the document, since Fannie Mae requires them as a part of the post-closing package the lender sends to them. You have nothing to fear if tax transcripts are required as long as you provided accurate tax returns to the lender. Any type of fraud will be uncovered with the tax transcripts, so it is not worth taking a chance with the process. In general, transcripts do not hurt your case when it comes to applying for a loan – as long as you are open and honest and let the lender include all expenses/income in your application in order for the lender to create the most accurate picture of your financial situation.

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