Are No-Doc Home Loans Dead?

You want to buy a home, but your credit isn’t great, and you don’t have a large income. Will a hefty down payment help you qualify for a mortgage loan? A Credit.com reader says she is selling her current home and plans to buy another in a year. But there are two obstacles she’s worried could stand in her way.

One is her income. She says:

For income, I am not working and only have Social Security income of $970 per month. I do not have any income tax paperwork for the last several years as I did not work — just started getting Social Security checks this past February.

The other is her credit.

I have never been late on a mortgage payment. I am in the process of cleaning up the few irksome problems I have on my credit report. (Once I sell my house my credit report/FICO score should take a big jump up). I am showing late payments to two lawn care companies and one trash company on my credit reports. All other credit cards (3) I have a great record with. I have one charge-off for Chase Bank where I paid a settlement amount on a charge card.

But our reader says she can make a large down payment on her next house:

With this in mind, would I be able to purchase another house next year putting down about 45% to 50% on the amount of the house? I plan on purchasing a house for around $150,000 and putting down at least $65,000 next year when I come back.

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A few years ago, our reader might have been steered toward a “no doc” or “low doc” loan where she would have to provide limited information about her income. But those loans are pretty much dead.

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“There are no “No Doc” mortgages available from traditional lenders,” says Joe Kelly, president of ArcLoan.com, a national mortgage firm. He says that no doc loans may be available from “portfolio lenders,” such as credit unions or community banks. But he warns, “Any no doc loan would require very high credit scores, low LTV (loan-to-value), and other compensating factors.”

And, unfortunately a large down payment doesn’t mean the lender can overlook a small income. “Due to recent laws, lenders are now required to make a reasonable determination if a borrower is able to repay the new mortgage loan applied for,” explains Jeanine Thomas, a mortgage broker and principal of J Thomas & Co Inc in Sarasota Florida. “I’ve had borrowers with 90% down payment and 800 credit scores and because they do not have proof of any income, no one will touch them,” she warns.

But that doesn’t mean all is lost here. Social Security retirement benefits are a perfectly legitimate source of income, and as long as that income is expected to continue for three years — which in this case it definitely will be — it can be used to help qualify for the loan.

In fact, it may be worth even more than she thinks. “If the $970 is coming from Social Security and is not being taxed federally then it can often be ‘grossed up’,” Kelly explains. ” In this example, $970 x 125% = $1212.50 per month of income for loan qualification purposes.” That means “She would qualify for a payment of $400 — $460 per month depending on other factors such as credit scores,” he says. Our reader must keep in mind that the payment would include taxes and insurance, as well as principal and interest.

The fact that our reader hasn’t filed tax returns for the past couple of years is not an obstacle, either, says Thomas. She says a lender can use IRS Form 4506-T (Request of Transcript form) to validate that the borrower did not file for those years because she wasn’t required to do so.

[Related Article: I’m Bankrupt, But I Want A Home]

As long as her expectations are reasonable and mortgage rates remain low until she is ready to buy, it sounds like our reader’s income should be enough to buy a modest home with a large down payment. She may have to set her sights on a less expensive home, depending on what taxes and insurance run where she plans to buy, but hopefully she can find a home that meets her needs.

But what about her credit?

That could be an obstacle, but will hopefully not be insurmountable. I emailed her and asked her if she had obtained her credit scores recently. She replied:

“About my FICO score — afraid to check it — eeeek…..” She told me she wants to clean some things up first.

Of course, I am going to encourage her to take the plunge now. She can purchase her FICO scores or use Credit.com’s free Credit Report Card to get a score, but she needs to see what factors are weighing most heavily on her credit scores and map out a realistic plan to improve them.

Paying off her mortgage won’t likely provide raise her scores like she is hoping it will. Paying off installment accounts like mortgages or car loans doesn’t typically raise credit scores that much. But if any of her three credit cards have high balances, paying them down could give her scores a nice boost.

I assume the trash and lawn care accounts she mentioned are in collections since those types of accounts don’t usually show up on credit reports otherwise. Paying off collection accounts doesn’t typically raise one’s credit scores. But she may be able to negotiate with the collection agencies to remove them if she pays them off. There’s no guarantee that will work, but it doesn’t hurt to try.

As for the charge off, that’s a seriously negative item credit, but the impact to the score depends in part on how old it is. And as time goes by, it has less of an impact, particularly if she is paying her current accounts on time. Finally, I wouldn’t encourage our reader to make any major credit moves right now; she shouldn’t close out current accounts or open new ones, for example, because doing so may lower her scores.

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Image: Diana Parkhouse, via Flickr