The Mortgage Scrolls

5 Pillars of a Home Loan

Written by Mortgage Sensei | May 23, 2024 7:19:02 PM

5 Pillars of a Home Loan

Become the qualified Buyer that Lenders are looking for!

Understanding what components make up a home loan will give you the advantage of being able to take the right steps towards homeownership.

I’ve been in the home lending industry since Fall of 2011. In that time, I’ve had to go through the highs and lows of understanding the home lending process. In my experience, I’ve had numerous conversations with clients that simply did not understand the home lending process. As I gained more experience, I coined the “5 Pillars of a Home Loan”. When I started explaining the lending process in this fashion during my initial consultation calls, my clients were able to quickly grasp the concept of the risk assessment of lending. This led to a boost in confidence in my clients which gave them the courage to take action. In writing this post, I’m hoping that I can go from a limited one-on-one conversation and expand my reach to communicate this concept to a larger audience to help more people find their confidence to realize that the process of homeownership doesn’t need to be this mysterious or unattainable process. It’s open to whomever is willing to obtain it.

The  5 Pillars are:

  1. Credit
  2. Repayment Ability
  3. Funds Needed for Closing
  4. Subject Property
  5. Loan Program

As a Borrower, before you even get started the first three pillars are the most important actionable categories you will be preparing for BEFORE you try and get pre-approved or go under contract for purchase.

Credit:

Of course this is an obvious point. But the key to understand here is this concept: “Before the lender extends you more credit, they must first determine your creditworthiness by evaluating your current credit profile”. Think about it this way: If you have a friend, and they ask you to borrow $200.00, but that has a history of never paying people back on-time/ever. If you had it to lend, would you do it? If we’re honest with ourselves, we would say no; of course a strong emotional attachment would say otherwise, but even in that statement we must deal with the reality that lenders don’t have a strong emotional attachment to their customers, outside of paying their bills on-time. This isn’t a charity, as they would say. If you want to know how to go about working on your credit, I would suggest going to https://www.myfico.com/credit-education. There you will get a TON of free information on how credit REALLY works. If you are in a position where you need credit repair, then my good friends at Kredit Kleanse have a very good track record of helping people Kleanse their credit.

Repayment Ability: 

Think “personal cash-flow”. The technical lending term is debt-to-income ratio “DTI”. This is what mortgage licenses were originally created to address: to ensure lending professionals are taking the appropriate action of making sure the borrower can actually afford the home loan so that we don’t have the 2008 housing crisis all over again. The equation I use is (credit debts + court debts + proposed subject property housing expense) / (Total calculated gross income). The numbers used will vary program to program, but overall this is the basis in which all DTI is calculated. There are two distinct DTIs: 

  1. “Housing DTI” which is ONLY: (proposed subject property housing expense) / (Total calculated gross income). A ratio of 30% is considered “healthy”
  2. “Total DTI” This is the complete equation: (credit debts + court debts + proposed subject property housing expense) / (Total calculated gross income). A healthy ratio is 45%. 
  3. Key takeaway. Knowing EXACTLY what your DTI is will vary based on (1) the market in terms of what the fed-rates are, (2) which lender you are getting approved through since lenders decide their own margins and loan-pricing-levels which will dictate the final interest rate used for your housing payment, (3) the selected loan program, due to the requirements for things like debt-calculations and housing expenses like PMI, and (4) The subject property housing expenses like property taxes, homeowners insurance premiums, and community dues like HOAs.

Funds: 

There’s 4 REALISTIC categories that you must consider when trying to purchase a home with a loan:

  1. Down-payment: People like to lump this into closing costs, but by true definition that’s simply not the case. Down-payment is a “MIR” minimum investment requirement, meaning that it’s not truly a cost (a cost is something you “spend” to acquire something). In the sense of a down-payment you are converting your liquid-cash into a hard-asset which is home equity. With this clarity, you can expect to get your money back at a later date whether that’s through selling or cash-out refinancing your home. You can put down as little as 3% of the purchase price, and there are loan programs available that don't require a down-payment like with VA loans, USDA loans, and down-payment assistance loan programs.
  2. Transactional Costs: This includes appraisal costs, title costs, government fees, inspections, lender costs, etc. Typically this amount ranges from 3-6% of the purchase price and greatly depends on what market your home is in along with the final loan structuring. There are ways to get most of these costs covered. It’s best to consult with a mortgage professional to know what your options are. 
  3. Reserves: This is not always required for a home loan, but if it does come up during your approval process, it’s good to know just what the heck lenders are talking about. In short what this means is: “after all the necessary transactional funds”, how many monthly total housing expense payments do you have remaining in your account(s). Example: If your proposed total housing payment is $3,865/mth, and you have $52,862 left in your account(s), then you have 13-months of reserves remaining in your account.
  4. After transaction expenses: This last point has no bearing on whether you will get approved for a home loan or not, but it is something that needs to be addressed, as some people are so excited about becoming homeowners that they forget non-transactional costs like: moving expense, deposits for utilities, time away from work for relocating, housewarming parties etc. These costs are completely unknown and not factored into your home buying process, and falls in the category of “living expenses”.

Subject Property: 

Of course buying the right home for you and your family is most important to you, but when it comes to finalizing your loan approval to get to the closing table, these are the factors that the lenders care about:

  1. Loan-to-Value “LTV”. Without losing you with all the LTVs that there really is, in this context is do you have the minimum required equity requirement in the home according to the loan program. In ALL cases even if you have 50% equity in the home, if the loan program requires a MIR down-payment then you would have to bring those eligible funds to the closing table.
  2. Property Condition: Is the property habitable? Is the property safe in terms of potential obstacles that could cause injury to you or another person. In the appraisal report, there’s a property condition report that outlines these conditions. Different programs have different program requirements, so you may hear Sellers say I only want to sell to a person that has a conventional home loan knowing that conventional loan programs are the most lenient when it comes to property conditions required for final loan approval.

Loan Program: 

This last pillar is more along the lines of the first 4 pillars being weighed against. In other words does your credit, DTI, Funds needed for closing, and subject property fit within the guidelines of the loan program. As you change loan programs the whole lending process changes, and even “meaningless” changes can affect your ability to close on the home. Working with the right company and professional will make all the difference in getting that home you want. Some lenders ONLY work VA loans, or don’t do USDA loans, or have “lender overlays''. A “lender overlay” is an additional guideline the lender places on-up of the actual loan program guideline. Having a consultation call with a lending professional to determine what they are capable of can save you a lot of time and stress.

A couple of my deals:

There’s one deal that comes to mind, and for the sake of privacy I will refer to the client as Gina. Gina was looking to purchase a home, but everything she went to a lender, she always got denied, but never received a clear explanation as to why. Eventually she got connected with me and we began to address each loan pillar. In doing so, it was uncovered that the funds that she was using were considered unsecured loan funds which is a no go for ANY loan program. Upon further inspection, I noticed that the funds were deposited into her account in about 45-days, with this knowledge I was able to leverage the proper interpretation of the lending guidelines. In short, we held closing another 2 weeks that way the deposited unsecured funds would be seasoned for 60-days and now would be considered eligible funds for closing. If the previous lending professional knew this they would have gotten the deal done.

Another deal I did, and again for the sake of privacy I will refer to the client as Ben. Ben had found a home that he wanted to buy, however when the appraisal report came back, there were some property conditions that neither the Seller or Buying was willing to fix, because it totaled over $40,000.00. Instead of denying the loan, we changed the loan from FHA to FHA 203k which is a renovation purchase loan, and was able to finance the cost of the repairs into the loan. A lot of lenders don’t even offer this special loan program let alone know how to actually do it late in the lending process.  

What I always tell people:

Most people are just too afraid to buy a home, because it seems like such a lot of steps to get into a home. And to those people I would say you’re ABSOLUTELY correct (not what you wanted to hear huh?). The truth of the matter is that the home buying process is difficult, but the great thing about it is that you don’t need to know everything, you just have to know the right person that does know. 

Another misconception is that you have to have perfect credit to buy a home, and that’s not true! I’ve gotten a lot of people with sub-600 credit scores into a home. 

Lastly, getting with an experienced and knowledgeable professional early could make a huge difference. For instance there was a wonderful lady I helped become a homeowner, but it was a whole 2 years before she was ready! The key was that she had her free consultation call early, when she didn’t know which way was up. I was able to give her an action = plan that actually works, and she took my advice and implemented everything I told her. During those two years, she had challenges and unexpected financial situations that came up that ended up delaying her progress. However, she preserved and never gave into the setbacks, and now she’s a proud homeowner. You could be next! 

My take on it:

Through my 12+ years of experience, I’ve seen a lot of different financial situations, and the overarching commonality is that there’s always a creative way to get anyone into a home. It could be on your part in the form of financial changes, discipline, knowledge, etc.; or  the experience, knowledge, creativity, etc. of the loading professional. Is this a difficult process, yes! But it doesn’t have to be hard! ANYONE can own a home, and if you have made it this far, then that means you have the ability to become a homeowner. 

When looking to use ANY financial loan instrument, the first 3 pillars are what you should be constantly working on. Focus on becoming a well qualified borrower and lenders will love lending you money because your behaviors display financial & credit worthiness. Ask yourself: “What if I am considered financial & credit worthy to lenders?” & “How do I go about becoming this person?”. Swallowing the red pill and putting in the work, will open doors that you could never have had imagined. 

There was a client of mine a couple years ago that implemented the strategies I gave her. I’ll refer to her as Susie, and this is her story: Susie reached out to me about buying her first home. She had good intentions: more space for her kids, tired of paying her landlord, building towards generational wealth, and a lot of other great points. She imagined “what if” I could make this work. When she reached out to me in the Fall of 2021 and had her free home loan consultation we were able to come to the conclusion that she was not financially ready to purchase a home. Instead of allowing the reality of her situation to destroy her dreams, she asked “how do I get ready”. At this point I had to get her to willingly swallow the red pill, so I asked if she was ready for me to be brutally honest? She said, “Yes, please! Nelson, I really want to do this!”. Then I said to her, “This is REALLY what the banks are saying behind closed doors, you simply don’t make enough money for the home you want. You got to make more money!”. She replied, “OK, then that’s what I’m going to do”. Now, in my experience, normally people don’t actually do what it takes to live the dreams they have. A few months went by, and she reached out to me the following Spring. When we reconnected over the phone, she said in a very confident tone, “OK Nelson, I’m ready now!”. We restarted her pre-approval process and she provided her bank statements. When I reviewed them I thought she was going to jail for criminal activities! Susie had saved over $200k, mind you her previous qualifying income was $50,000.00/year. So, how on earth did you get that much money in roughly 6-months? Come to find out, she became a tax preparer and made more money in 6-months than she’s made in the last 4+ years! I still had to do some creative loan structuring due to the loan guidelines on employment history, but she’s a homeowner now!

Final Thoughts:

By understanding the 5 Pillars of the home loan, you can come up with a good plan to work towards homeownership. If you are trying to get prepared to buy a home, then focus on the first three pillars to become a well qualified borrower. They are:

  1. Credit
  2. Repayment Ability
  3. Funds needed for closing
  4. Subject Property
  5. Loan Program

The time between when you have a good idea and the moment you act on that idea is the #1. #2 is executing a plan consistently over time in spite of the hardships that may arise. The first step is getting the right information from an experienced & knowledgeable professional. If you made it this far then you can become a homeowner. It’s as simple as scheduling a free consultation call with me by clicking HERE. As a bonus you’ll get a copy of my book “How to Buy a Home with a Loan” for FREE! It’s NEVER too early to start. Get the right information today!

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