SANTA CRUZ (January 9, 2010) - Mortgage approvals are based on a borrower’s income, credit and cash available. The income must not only be adequate but stable, which basically means that the borrower has a steady two year history of work in the same field. The income that a salaried employee is making at the time of the loan approval is the income that is used to calculate the all-important Debt-To-Income ratio (DTI). For self employed borrowers, the income that we will use to calculate the DTI is derived from averaging the net profit from the borrower’s Schedule C on the two most recent years of federal tax returns, providing the income is increasing from year to year. If the income is decreasing, the underwriter will expect an explanation of the decline and will probably use the net profit as reported on the most recent tax return.

The credit report that is used to determine the borrower’s ability and willingness to pay back a mortgage provides a seven to ten year history of a borrower’s payment history. Each of the three national credit bureaus (Trans Union, Experian and Equifax) independently calculates a credit score that ranges from 350 – 850. Generally, borrowers with scores below 640 are not eligible for a conventional or government mortgage. Although there are numerous factors, borrowers receive low scores primarily due to not making their previously agreed upon payments on time. The good news is that bad credit rectifies itself over time; though, there is no quick fix.

Of the three key ingredients required to obtain a mortgage, both income and credit are based on a long history and cannot be modified or rectified in the short term. On the other hand, providing adequate funds exist, a borrower has the control to meet the cash requirements of a mortgage. With this control also comes the ability for the borrower to completely screw up the works. Those of us working with borrowers have seen this all too often. Perhaps the biggest challenge comes into play when a borrower decides to start transferring monies around prior to the close of escrow. Conventional wisdom may suggest that the lender will not care where the cash comes from as long as it shows up in time to cover the down payment and closing costs. Nothing could be farther from the truth.

The lender expects the borrower to carefully document every transfer of funds and every deposit over the past two months that is not from a paycheck. If we have verified that a borrower has adequate funds to close escrow in one account but at the close of escrow the borrower pulls the money from another account, no deal. The transfer and liquidation of the borrower’s funds must be documented. Given the risk of not being able to close escrow, borrowers are well advised to not do any last minute transfer of funds.

In most cases gift funds are acceptable for all or a portion of the cash requirements. Gifts must come from a relative and must also be documented. The donor must prove he or she had the funds in an account (cash gifts are not allowed) in the first place and then the borrower must prove the funds were received from the donor. The donor is also required to provide a letter specifying the amount of the gift, the relationship to the borrower, the address of the new home and the fact that the gift has no payback responsibilities.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.