Navigating today's mortgage market

Part 1 of 2: Loan approval tougher for prime borrowers, self-employed

By Bernice Ross
Inman News

(This is Part 1 of a two-part series.)

You have a buyer purchasing a high-quality new home with 20 percent down, excellent credit and fully documented income, including two years of documented tax returns -- it's a no-brainer on getting loan approval. If you think that's statement is true, think again.

Today's lending environment is rapidly evolving from one where almost anyone could obtain a loan to one where even the most qualified borrowers may be sweating about obtaining loan approval. The "good old days" of taking orders are dead. Instead, to survive in this new and often hostile environment, you will need strong negotiation skills coupled with strategies on how to avoid loan problems. As credit standards tighten, expect to see more of the following types of scenarios:

1. "Stated-income" loans: RIP

"Stated-income," or "easy qualifier," loans are becoming harder to find. In the past, lenders made an approval based upon the strength of the buyer's down payment and credit history. They did not verify tax returns. Due to the increase in interest rates coupled with the subprime fiasco, even A+ borrowers are now encountering closer scrutiny. Don't be surprised if your buyer applies for a "stated-income" loan and the lender comes back requesting tax returns and complete documentation. These fully documented loans, where the lender carefully scrutinizes the borrower's credit and fully documents the borrower's income, are the new gold standard for making loans. As a result, both agents and clients will have to cope with tougher underwriting standards and more borrowers who will fail to qualify.

In order to make sure your transactions close, have buyers preapproved, not just prequalified. "Preapproval" means that the lender has checked the borrower's credit and verified income. All that is necessary to close the transaction is the appraisal on the property and the title report. In contrast, when buyers are "prequalified," the lender has seen the buyer's loan application but has not verified credit. Prequalification means that the lender will approve the loan, provided the credit, appraisal and title check out properly. Thus, it's smart to have all buyers obtain preapproval before ever taking them out to look at property. If the buyers resist this process, chances are they have problems that will prevent them from closing a transaction. Don't waste your time. If you are representing a seller, don't take one of your listings off the market until the buyer has obtained loan approval. An even better solution is to make a note in the Multiple Listing Service that the seller requests a preapproval letter with any offer.

2. Tax returns are no longer an option for the self-employed

When lenders do a fully documented loan, they thoroughly examine the borrower's tax returns. This is especially true for anyone who is self-employed. Part of the challenge in working with self-employed buyers is that they tend to be aggressive on their deductions. This brings their net income down, which makes it harder for them to qualify.

If the buyers decide to address this issue by doctoring their tax return data, they can end up in serious trouble. "Defrauding a lender" can result in serious fines and even imprisonment. Furthermore, they also run the risk of the IRS prosecuting them for tax evasion. In the past, it was difficult for lenders to cross check what was filed with the IRS. Today, lenders can call the IRS to verify whether the income the buyer claimed is the same number he or she filed with the IRS. Again, working with preapproved buyers can help you reduce many lending hassles.

3. Protect your sellers from rising interest rates

When I started in the business in 1978, interest rates were rising. (To put this in context, fixed rates were 10 percent and "variable" rates were 9.75 percent.) By early 1979, rates were above 10 percent and no one ever thought we would see single-digit rates again. There are two important practices from the past that are critical in today's mortgage environment.

First, if you are representing the seller and the buyer's agent writes in an interest rate of 6.75 percent, it's smart to counter that the buyer will accept up to a 7.25 interest rate. Be sure to request documentation that the buyer can qualify for a loan at the higher rate. It's also smart to counter that they will take an adjustable-rate mortgage in case they don't qualify for a fixed-rate mortgage. Remember, if the interest rate exceeds the amount in the contract, the buyer has the right to cancel the transaction.

Second, never write in "prevailing rate." You don't want your buyers applying for a 7 percent loan and learning they have to take a 9 percent or 10 percent loan because they have poor credit.