How long do need to be employed to qualify for a home loan?

The quick answer to this reader question is that it is preferred to have at least 2 years employment history. But getting a mortgage isn’t quite that cut and dry.

As we all know lenders have been hit hard with blame for the recession. They’ve been required to be more stringent in lending and have become much more cautious. Your income history is one of the best measures they’ve got to ensure that you’ll be able to make your monthly payments, though it still a risk on the lenders part.

Before mortgage lenders can grant you a loan, they of course would like to make sure you can repay them. They’ll need to know:

• your credit history
• your gross income each month
• the amount of money you plan to use as a down payment

The Debt-to-Income Ratio Explained
A big part of the lender’s concern is your debt-to-income ratio. There are two calculations used to determine this number:

Front-End Ratio
This calculation determines how much of your pretax income will go towards your monthly mortgage payment. The mortgage payment figure includes interest, principle, taxes, and insurance and typically should not go over 28% of your gross monthly income.

Annual Salary x 0.28 / 12 (months of the year) = Maximum Housing Expense

Back-End Ratio
This calculation determines the amount of your total gross income that will go to pay all of your other obligations, including the mortgage, other loans, child support, credit card bills, and any other monthly debts. The figure should not exceed more than 36% of your gross income.

Annual Salary x 0.36 / 12 (months of the year) = Maximum Allowable Debt-to-income Ratio

Different lenders will have different requirements for the debt-to-income ratio. For instance, conventional loans — typically a conventional loan from a bank or other mortgage lender — will require no more than 26% to 28% of month gross income for housing costs and not more than 33% to 36% of monthly housing plus debt costs. With an FHA loan, the housing costs should not exceed 29% of the monthly gross income and 41% of the monthly gross income.

And it’s not impossible for self-employed people to get a loan. You’ll just need to show not only that you were gainfully employed, but also what your net income was compared to business expenses. Self-employed people will also need to show a profit-loss statement. If you don’t keep good records of legitimate business expenses, don’t have your taxes professionally prepared, and guesstimate your profits and losses, the loan process could come to a halt very quickly for you.

Before you co-sign a loan

A long, long time ago a certain relative (no names, you know who your are) asked me to co-sign an auto loan and I said, "no".

I felt cruel and heartless. This person was desperate. She needed a car to get to her job. But she didn't have a credit history and couldn't get a loan. There were tears, but no blame.
Why did I say no? Because I knew this person. I knew how badly she handled money. More than that I knew that I couldn't afford to take on another car payment, which might happen if (or more likely when) she defaulted on the loan.

As a loan co-signer you agree to ensure that the loan will be paid back. The lender doesn't really care who pays it, as long as it's paid. If the primary borrower defaults or skips town, you're likely to be held liable. Typically, the lender can come after you first, without trying to collect from the borrower. And so, you could:

• be required to pay late fees or attorney fees.
  have your wages garnished.
• lose any property you put up as collateral

Not only that but your credit score could be affected by the primary's default or late payments. And if you are planning on a purchase such as a house or car for yourself in the near future this co-signed loan will appear on your credit history.

Before you agree to co-sign on any loan review the situation.People only need a co-signer for one of two reasons: 1) they do not have a credit history, or 2) they have really poor credit.

If the person you know falls into the first reason think about how well you know them. The loan already creates a legal agreement that they are expected to make payments, but do you think they have the capacity to do so? Do they have a job? Do you have any reason at all not to trust them?

For wannabe borrowers who fall into the second category of poor credit, do you know how they got there? How long have you known them? Instinct should tell you if someone is a high-risk.

To protect yourself you can do what I did and just say, "no". Or, you could try asking the lender to write an agreement into the loan stating that you would only be responsible for the balance of the loan at time of any default. This could save you legal fees later.

Don't get me wrong. Co-signing isn't all bad. If you know someone who is young or recently divorced they may not have an adequate credit history. Your co-signing can help them begin to build credit--which is important as they continue in their life.

As for the one that I said "no" to--She got a car the old fashioned way. She continued to borrow a car to get to work then saved enough to buy a used car. It wasn't as pretty as the brand new car, but it worked great and I think it helped learn some financial discipline.

Social Lending is Catching on

Beyond Twitter, Facebook and LinkedIn loads of people are using social network to find friends with money that will help them pay off their bills or build their businesses. A year ago I would have thought this was just crazy talk, but as the ecomomy kept sliding social lending has gone wild.

It's call Peer-to-Peer Lending or P2P Lending. Sites like the Lending Club, Prosper or Zopa have been at it for several years. Borrowers post their needs for anything from fixing broken appliances to raising capital for their small business. Lenders are more like investors. As a lender you can shop for a cause that you consider worthy, pledge the money and eventually collect your loan with interest. Some lenders enjoy the goodwill of helping others. And some are in it to make themselves some cash.

If David Bowie needed cash now he might try social networking rather than using Bowie Bonds and being blamed for bringing down the global economy.

Irresponsible Lending Continues

I have a friend who is a single mom of three kids making $30,000 as a preschool teacher and living in an historic house in Gloucester, MA. This summer, right smack in the middle of a housing crisis and finger pointing at irresponsible lending, my friend found her finances giving an uncomfortable squeeze. She went to her bank for a home equity loan. She didn't need to use the loan right away, but wanted it there in case that squeeze became a strangle. She asked the bank for $25,000. Her house is valued at much more than that, but she didn't want to get into a bad debt situation. You know what the bank did? They offered her $400,000.

My friend was shocked. "Are they crazy?" she asked me. She went back to the bank and asked them if they were indeed crazy. She pointed out that she only earns $30,000 and as a preschool teacher isn't likely to earn much more in the future. The bank actually proceeded to argue that the loan was in her best interest. After much back and forth she was finally able to talk them down to the $25,000.

So several things are going on here. Maybe the bank was hoping that she'd eventually default on her loan and they would then gain her historic and valuable house. Or maybe they were only looking at their own loan income. Or maybe they really were crazy. No matter how you look at it this is a fine example of irresponsible lending. The amazing thing is that this behavior that got us into our current economic mess still continues.