Kelly was an upperclassman at George Mason University in Fairfax VA. She was tired of dorm life and wanted to live off campus. Her parents suggested to her that she buy a home near campus and rent a few rooms to other students to help cover her mortgage. Under that plan, her housing costs would be less than if she rented an apartment. She thought this was a wonderful idea. She was an industrious young women and actually had a well paying job on the side. While the income from her job could cover her expenses and part of the rent, it would not be enough for her to qualify for a mortgage. Her parents agreed to co-sign. And due to an inheritance received from a relative, she had substantial money for a downpayment. In fact her target range for the home was $300,000 and she could easily put down $75,000 Even after that, the inheritance would total over $500,000, more than double the mortgage she wished to obtain.
DOWN THE CONVENTIONAL ROAD
So off to a lender Kelly and her parents went. They had heard about this nasty thing called PMI or private mortgage insurance. PMI is a monthly fee charged by lenders to help cover losses in the event of default and often runs 100s of dollars per month. However, when a buyer puts down more than 20% on a conventional loan, there is no PMI requirement. Kelly and her parents thought that with their huge downpayment, they could avoid PMI.
Well, their first surprise in the lending maze was that they did not qualify for a conventional loan. Conventional loan rules require the owner occupant must qualify based on their income. They can have relatives co-sign but only if the owner occupant qualifies on their own income.
U TURN TO FHA
However, the loan officer said they would perhaps qualify for an FHA loan. FHA loans allow non-occupant co signers who are relatives and will qualify based on total income and debts of all parties. This was fine as Kelly’s parents had great income and limited debt.
NO CREDIT SCORE STOP SIGN
So, the loan officer ran everybody’s credit report. Kelly was very conservative when it came to finances and never wanted to have any debt. She paid cash for everything. She had no credit and thus no credit score. This loan officer said, they could not do the loan. They could use the combined income for Kelly and her parents but their firm required all buyers to have a credit score.
Undeterred, they called around and found a reputable lender at a firm that did not require credit scores for all applicants. Kelly and her parents were excited. Then the PMI, or in FHA terms MIP monster, (mortgage insurance premium) reared it’s ugly head. On 30 year year FHA loans, regardless of the downpayment amount – it could be 60% – there is a monthly MIP charge. No way around it. And it can not be removed for several years. On a $225,000 loan this would add about $225 per month to the payment. I hated to see them waste that money.
I suggested that the parents buy the property as an investment and not include Kelly. Over the next few years, Kelly could take out a few credit cards, gets a score and then they “sell” the home to her when her income increases. This had it’s own set of risks, mainly the uncertainty of interest rates down the road. Plus life changes and other financial factors could get in the way of such a plan.
SPEED LIMIT 15
We then discussed a 15 year FHA which avoids the MIP charge if the loan to value is less than 78%. That is the path they took. At 3.75% on a 30 year loan the payment for principal, interest and MIP was about 1290. On a 15 year which has a slightly lower interest rate, the payment, with no MIP was about 1630. Yes, it was more but it was something they could afford and money well spent vs wasting money on MIP.
Why well spent? Kelly has plans to sell the home is about 7 years. A $225,000 loan amortized over 30years at the end of 7 years will have a balance of $192, 000. That same loan amortized over 15 years at the end of 7 years will have a balance of $135,100. That means she will have $56,900 more in equity when she goes to sell. Over those 7 years she will have paid about $28,000 more in payments but still much better than paying worthless MIP and having a higher balance. (For those of you who really understand mortgages, yes, I know the $28,000 would likely be a little more as she would probably drop the MIP before 7 years but nonetheless, this is the smarter way to go.
I really like helping people find solutions to problems like this. Some folks think they can’t buy and it gives me great satisfaction to help them find a way to do so. And others, like Kelly, can buy. however, when I see an injustice in the system, I will try every which way to put my client in a more favorable position.
CAN WE GET SOME COMMON SENSE RULES OF ROAD PLEASE?
Kelly is a combination of several clients I have had over the years who encountered qualifying problems based on co-signers or lack of credit. I have had more than one client who lived life on an all cash basis, had no credit score and had more than 3 times the price of the house in cash in the bank. Yet they could not get a loan. Where has the logic gone? Yes, I guess someone with 2 million in the bank buying a $500,000 home and putting down $250,000 could default but, really, what are the odds? Sadly the mortgage system is based solely on credit and income and does not respect assets. Oh well. We need to play within the rules and I always try to find a way to make it work.
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