Introduction to Real Estate Investing - Chapter 1: Mortgage Qualification

Introduction

Welcome to the world of real estate investing! Real estate can be a great way to build your wealth - if you know what you're doing. We’ll cover everything you need to know about starting your real estate investing journey, from house-hacking and using owner-occupied financing - to buying small multi-family properties - to how to qualify for mortgages - and add value to properties through renovations and other improvements. Plus, we’ll have a bonus chapter on how splitting larger lots into smaller lots can create extra wealth and slingshot your portfolio growth. Whether you're new to real estate or already have some experience, this content will provide you with the knowledge and tools you need to get started in this lucrative industry. We'll start with an overview of house-hacking and how it can help you get into the market with minimal risk and cost. House-hacking is a technique that allows you to purchase a single-family home or small multi-family property with owner-occupied financing. Essentially, it allows you to live in part of the property while renting out the other units, helping to offset mortgage costs. You'll also learn about qualifying for mortgages so that you can make a sound investment decision based on your financial situation or how to get mortgage-ready. Next, we'll explore ways to add value to properties through renovations, adding rooms, and other improvements. This is important because it can help increase the value of the property while also making it more attractive and desirable for potential tenants or future buyers. We'll also cover tips and tricks for finding good deals on properties to maximize your returns. Finally, we have our bonus chapter on splitting larger lots into smaller lots as a way of generating extra wealth. This is an often overlooked but powerful technique that can be used to build long term wealth from real estate investments. We'll look at how this works and discuss steps for getting started in this area of real estate investing. By the end of this, you'll be armed with all the knowledge and tools needed for successful real estate investing. We hope that these insights will help open new opportunities for building wealth through smart investments in real estate properties, no matter what stage of life you're in!

Chapter 1: Qualifying for a Mortgage

Mortgage qualification can be a confusing and daunting process for many potential home buyers. There are many misconceptions about mortgage qualification and home purchases that lead to confusion. In this chapter, we aim to provide a basic understanding of the mortgage qualification process, credit scores, and how to improve a bad or nonexistent credit score. Additionally, this chapter will discuss how income and other factors affect mortgage qualification.

Most Common Misconceptions of Mortgage Qualification

One of the most common misconceptions about mortgage qualification is that it is an extremely long and complicated process. While it is true that there are many steps involved in the qualification process, it does not have to be overly complicated or time consuming. With the right preparation and knowledge, the mortgage qualification process can be completed quickly and easily. A great lender will make the process smooth and be able to guide you throughout the process.

Another misconception about mortgage qualification is that you need perfect credit to qualify for a loan. While having good credit is important when trying to qualify for a loan, it is not necessary to have perfect credit to be approved. In fact, many lenders offer mortgages even if you have bad credit. There are programs available that help borrowers with lower credit scores – specifically, the Federal Housing Administration (FHA) loan programs allow for scores as low as 500.

A third misconception about mortgage qualification is that you must have a large down payment (20% or more) saved up to qualify. While having money saved up for your down payment does help when it comes time to apply for a loan, it is not necessary to put down that large of payment to be approved for financing – particularly with owner-occupied loans (meaning you live in some portion of the property). Depending on the loan program used or your unique situation, you can purchase a property for as little as 3.5-5% down. A far cry from 20%!

The Basics of Mortgage Qualification

? The first step in the mortgage qualification process is finding a trusted lender. The best way to find a great lender is by referral. Ask friends, family, or other real estate professionals (your real estate agent) who they have worked with and would recommend. After you connect with a lender, you’ll then need to complete an application. The information gathered will be used by your lender to determine whether you qualify for financing and what type of loan terms they can offer you. They can also coach you and help you work towards qualification if you aren’t quite there yet.?

Once your application has been submitted and reviewed by your lender, they will then run a series of checks on your credit history to determine what kind of risk you pose as a borrower. These reports tell your lender what loans you currently have and your payment history. Your lender may require additional information from you such as proof of income or assets before they can make an approval decision. This usually involves providing copies of paystubs, tax returns, bank statements, current mortgage statements (if you have any), etc. This tells the lender your financial story.

After all the required information has been submitted and reviewed by your lender, they will make their final decision on whether you can receive financing for the purchase of a home and on what terms. These terms include the interest rate, loan amount, purchase limit, and specific loan programs available to you.

Credit Scores & How They Work

Credit scores are one of the biggest factors affecting your ability to borrow money. Credit scores are used by lenders when assessing an individual’s risk profile before approving them for financing. Credit scores are calculated based on information contained within an individual’s credit report including outstanding debts, payment history and total amount owed among other factors. Generally speaking, higher credit scores indicate lower risk while lower scores indicate higher levels of risk associated with lending money out to an individual borrower.

They also play an important role in determining the types of loans you may qualify for as well as what interest rates lenders can offer you. Borrowers with higher credit scores receive more favorable terms than those with lower scores. The biggest being your interest rate. Therefore, it’s important that borrowers work hard at maintaining their credit score prior to applying for financing if they wish to receive better terms. But, if your credit score does need some help, the following suggestions should help.

?How To Improve a Bad or Nonexistent Credit Score

Improving one's credit score can take some time but there are several steps that can be taken towards improving one's score:?

?- Pay bills on time: One of the best ways to improve one's credit score is by paying bills on time every month - this shows lenders that one is reliable when it comes time for repayment. Not all bills report to credit bureaus when paid on time – which would help borrowers. But ALL bills that get sent to collection for nonpayment show up to negatively affect you. A bum rap, but that’s how it goes.

?- Keep credit balances low: It's important to not only pay bills on time but to also keep balances low on any existing lines of credit - this shows lenders that one is responsible with their borrowing. This mainly concerns credit cards. Having a credit card with a high balance (compared to your credit limit) hurts your score. As a rule of thumb, try to keep balances below 30%, but preferably lower than 20%.

?- Reduce debt: Reducing existing debt levels helps improve one's debt-to-income ratio which boosts credit scores over time. If you have lower balances on credit cards or smaller car loans – your payments will be lower. Shocking, I know. The lower the total amount of payments you make, the bigger the loan payment you can qualify for. We’ll talk more about debt-to-income ratios later. ??

?- Monitor changes: It's important to monitor any changes made on one's reports such as inquiries or new accounts opened by creditors so that any errors can be rectified quickly. Signing up for a paid account through one of the big 3 bureaus, or a free monitoring service like Credit Karma, can help you keep tabs on your score. Any changes will show as alerts, and you can monitor your progress or tackle any issues that come up.

?- Dispute errors: When errors occur, such as incorrect late payments, on one's report it's important dispute them so they don’t negatively impact your score. Credit Bureaus do make mistakes. It’s actually pretty simple to dispute any inaccuracies on the bureau’s websites. If mistakes are shown, be sure to take care of them.

?Debt-to-income: How Your Income Affects Mortgage Qualification

Income plays an important role when qualifying for a mortgage. Lenders use this and other factors to determine if an individual possesses?enough financial stability to repay the loan. Your debt-to-income (DTI) ratio is calculated by taking the total monthly payments of your revolving debt (car loans, credit cards, mortgages, etc.) and dividing by your gross income (before taxes). If you work a normal W2 job this is pretty simple. If you have other sources of income your lender will work with you on how to arrive at the income you are allowed to use. Certain loan programs have different rules for how to count certain types of income (self-employed, rental income, etc.)

Lenders typically like to see your total DTI, counting your new mortgage, somewhere between 36-45% although some options exist to go higher.? This means that all your monthly debt payments AND your mortgage need to be less than 45% of your gross income. For example:

-?????????Debt: You and your spouse have the following debts: Total MINIMUM monthly credit card payments of $200, and car loan payments of $800 for a total of $1,000.

-?????????Income: You make $50,000/year before taxes and your spouse makes another $50,000/year. Your total income is $100,000/year. Quick and dirty math breaks that down to $8,333/month. To keep your DTI below 45%, you need to spend less than $3,749.85 on all debt, including the new mortgage.

-?????????Ratio: To find out how large of a mortgage payment you can make (including taxes and insurance) take $8,333 x 45% = $3,749.85. Subtract your current monthly payments of $1,000 = $2,749.85. This means you can afford a mortgage payment of $2,749.85.?

To qualify for a larger payment, you need to either increase your income or decrease your debt. Later on, we’ll take the above example and plug it into a real-world property example.

?Other Factors That May Affect Your Ability to Qualify For A Mortgage

There are other factors besides the income amount you make that determine mortgage eligibility. We won’t list them all here as your mortgage lender is the expert. However, the following subjects are worth talking to them about:

-?????????How long have you been at your job?

-?????????Are you paid on commission?

-?????????Are you self-employed?

-?????????Are you applying with another person? (Spouse, partner, family member, etc.)

-?????????What does the other person’s financial situation look like?

-?????????Do you have negative credit report factors such as missed payments or collection accounts?

Bottom line - call a lender and get started. Its that easy. Once you understand your financial situation and what you qualify for – you can start searching for something to buy.

Our next installment will cover house-hacking. We'll explore how you can buy small multifamily properties (2-4 units) with low down payments and reduce or even completely eliminate your personal housing expense.