The coronavirus has created a catch-22 for buyers — interest rates are at historic lows and affordability is on the uptick. However, tightened mortgage standards have made it especially difficult for first-time buyers to secure a mortgage and take advantage of the scales tipping in their favor.
Breon Price
“COVID has thrown a complete wrench into financing and the housing market,” Cincinnati-based Motto Mortgage loan officer Breon Price told Inman. “Yes, these homes are [for sale], but people can’t get qualified for them, and the amount of cash buyers out there is very small.”
“The unfortunate thing is in the first quarter [2020] and the tail end of 2019, the housing market was rolling,” he added. “We were set up for what would’ve been a record year for a lot of different companies and in a lot of different markets.”
“It’s sad that everything has slowed down, but we’re starting to come out of that.”
Although the approval process is more tedious than before, Price said not all is lost. With a clear understanding of the current lending landscape and some careful financial planning, buyers, even those who are self-employed, can get the home they’ve been waiting for.
Here’s what they need to know:
Inman: How have homebuyers been impacted by COVID-19? Is there any class of homebuyer that’s been hit harder than others?
Price: COVID-19 has impacted everyone. However, tightened mortgage standards impacted self-employed [homebuyers], harder and to a larger degree. But even your W-2 employees, especially your first-time homebuyers, have seen the brunt of it too.
It’s important to note that a first-time homebuyer is someone who hasn’t owned a home before or hasn’t owned a home in three years. If you sold your home five years ago and have been renting, then technically by Fannie Mae and Freddie Mac guidelines you are considered a first-time homebuyer.
With [first-time buyers] they want reserves. What makes banks, lenders, and underwriters feel very confident about a loan is reserves, and a reserve is one month of the total payment. If your principal, interest, taxes, and homeowners’ insurance payment is $1,000, underwriters are looking for at least three months of that.
If you have a home that’s worth $200,000, and your client wants to put down five percent, that’s $10,000. In that case, we’d ask your client for $13,000 — $10,000 for the down payment and $3,000 for the three-month reserve.
If we have a client that has a housing history, which means they’ve owned a home within the past three years, nothing really changed. We’re still going to ask for your 2018 and 2019 W-2. If you have a bonus or commission, we’re going to take a two-year average, but can get away with a one-year average with compensating factors.
If you have a higher credit score, then a lot of times, they will accept the 12-month average versus the 24-month average.
What’s the purpose of providing a reserve? What does it prove to the lender about the borrower?
The premise behind this is that the forbearance period for most homeowners will be from April to July. So we want to show that if we’re writing a loan right now if you were to lose your job in the future, we want to make sure you have three months saved up to make that mortgage payment.
Makes sense. However, from what I’ve heard anecdotally, self-employed borrowers are still getting the cold shoulder even with a down payment and savings in place. What ‘hidden’ factors might they be unaware of?
In addition to showing three months of reserves, we’re going to cut the adjusted gross income (AGI) on their Schedule C down by 10 percent. It’s not too bad, because it used to be a 30 percent cut, and at one time, Quicken Loans was cutting [the AGI] in half.
It was very, very hard for a while, but I think it’s going to stay at a 10 percent income reduction for a while. However, if we can show 12 months of reserves with our same scenario of a $200,000 house with 5 percent down, which is $24,000 ($10,000 + $12,000), we can use the full income for self-employed borrowers.
What’s the purpose of income reduction?
What everyone is super afraid of right now is a loss in jobs, and a 10 percent reduction covers revenue fluctuations and proves you can afford your home even if business slows.
In something like this where unemployment numbers are skyrocketing, what [lenders] are afraid of is that Fannie and Freddie are going to ensure these mortgages, give the money back to the bank, and then the loans won’t perform, meaning that borrowers will default or immediately put the loans into forbearance.
For example, if I write a loan for you and we close on it June 1, and July 1 rolls around, and you decide not to make your payment and call to say you’ve been affected by COVID-19, Fannie and Freddie will fine the lender seven percent plus take the commission back. They think that we should have known, or we could have predicted that a client would probably put their loan into forbearance within 120 days of the loan being funded.
That’s a big deal right now. Can a company withstand 50 to 100 of those [scenarios]? Absolutely. But if a massive amount of them get done, you will tank a company. So, that’s why borrowers are seeing banks across the country take different stances to mitigate risk.
[The reserves and income cuts] are common sense conditions. What gets a lot of people in trouble is that they spend their entire savings on their down payment, and they have nothing left over. I cannot tell you how many people do that, and it’s crazy.
If something goes wrong and a health pandemic happens, you’ve got to have something saved up so you can keep making payments.
Are there any other underlying factors that could impact a buyers’ loan approval?
The biggest problem self-employed buyers have, and this was before COVID-19, are their taxes. It’s a double-edged sword. When you’re self-employed, there are tons of write-offs because nobody wants to pay the IRS.
By the time they pay their certified public accountant to do their job and write their income down as low as possible, so they’re not paying taxes on it, and they come to us, we can’t qualify them. The number we use is based on their taxable income.
It goes the same way with W-2 employees because they think we use their net income. That’s not the case — we use your gross income. So we’re going to use the number on your W-2, not what’s in your bank account. People think writing your income down as low as possible is a good thing.
But when it comes time to buy a home, it can make it difficult.
What happens if someone loses their job between getting approved and closing day? How will lenders handle that?
So another huge thing that won’t go away for the foreseeable future is employment verifications. Let’s say we have a guy who works for Proctor and Gamble, a huge company here in Cincinnati. What we’ll do on the day of closing is in the morning, we’re going to verify he’s still employed.
In the back of our mind, we’re afraid this guy is going to lose his job, and we may be fined. So, we’re going to call Proctor and Gamble and ask them if Mr. Smith is still employed. And we’re going to take their 2018 tax return and their latest pay stub to make sure they’re still working 40 hours per week.
With self-employed clients, you really can’t do that. So that’s where the 10 percent reduction comes in again because there’s a higher risk, and it’s hard to calculate the real-time income.
How can real estate agents help their clients get through the lending process right now?
The biggest thing I tell the agents who work with us is to preach understanding. We’re all in this together, and we’re all trying to figure out how this will work because this changes on a daily basis.
On Tuesday, it was a 30 percent [income] reduction with just about every wholesaler we worked with. They just took it down to 10 percent today. Tasks that used to take us hours are taking days, and that’s the biggest thing a real estate agent could help out within the transaction.
Explain to your buyers that just because they’re not getting an answer within an hour doesn’t mean the answer will be bad. We just need more time than what it normally takes because there are so many other people involved other than the loan officer and the underwriter.
