Applying for a Mortgage – Part 1
So you’re thinking about becoming a homeowner. As a smart consumer, you and your household are preparing for this big financial step. If you’ve been considering homeownership for a while you’ve probably already considered the pros and cons of homeownership and whether renting or buying is the best financial choice for you and your family. You may have talked with other homeowners to better understand the responsibilities that go along with homeownership. You’ve probably played with some calculators for how much home you can afford or what your monthly payment could be among other things. You may have even started a downpayment savings plan. So what’s next?
Generally, once you make the decision to move forward towards homeownership you need to consider financing the purchase. In the current housing market, homes for sale don’t stay on the market long before they are sold. As a result, lender pre-approval can make your offer to the seller more attractive.
So what do you need to know before you apply for the mortgage loan? How would a lender make the decision to approve or deny your application?
When you apply for a mortgage loan, your loan officer will require a variety of information about your financial status, including employment, income, bank accounts, credit history, expenses, and so on. Once all this information is verified the entire application file is submitted to the lenders underwriter. An underwriter will review your loan application through an evaluation process to determine the risk involved for the lender. Risk is a measure of the likelihood that you will repay the loan according to the terms. So what information does the underwriter review and analyze during the underwriting process? How is risk evaluated?
There are specific factors that an underwriter will always review and other factors that are reviewed dependent on the lender and the products (or loans) chosen by you, the borrower. Although most individual factors alone do not determine the final recommendation made by the underwriter, there are some data points that will lead to denial of your credit application. As such, a smart consumer will review these factors prior to the submission of the application in order to address any potential issues and improve your odds of a successful loan application outcome.
The risk factors are divided into two groups: credit report factors and non-credit report factors. Credit report factors include credit history, credit balances owed, the number of inquiries in the last two years to open new credit, delinquent accounts, collections, public records (like judgements or bankruptcy), and previous foreclosures. Non-credit report factors encompass a wide variety of items such as equity and loan-to-value ratio, liquid reserves, debt-to-income ratio, loan purpose, loan type, loan term, property type, number of borrowers, length of employment, self-employed borrowers, and occupancy (will this be your primary residence or is it an investment property). All information is considered by the amount of risk and overall significance in the underwriting recommendation.
In this edition of the DebtEdge, we’ll look at how you can prepare in advance and make a plan to address any underwriting deficiencies within the credit report factors to present the strongest application with the lowest risk possible to the lender.
First, what is the story your lender sees when reviewing your credit report? Your credit report tells whether you pay the correct amounts to your creditors, in a timely manner. It also lists a record of how much debt you owe, any current or past public records, how often you have applied for credit in the last two years, and who you have authorized to obtain a copy of your credit report.
As a smart consumer you will want to obtain a copy of your credit report approximately six months before making your mortgage application. This provides you with an opportunity to review your credit report, investigate and resolve any mistakes, errors, or problems that are revealed. The six-month time frame is recommended, as this should allow an adequate length of time for any corrections to be completed prior to the review by the underwriter. We also recommend you work with a credit counselor or housing counselor to make a ‘soft’ pull on your credit report, which will not impact your score, unlike when a lender pulls your credit report.
For better insight into what the underwriter will be assessing during the review, let’s examine each factor individually.
Credit history – this information informs the underwriter of how well you have met the terms of previous credit opportunities. It also tells how recently your credit accounts have been opened; comparing your handling of credit in the past to how you handle credit now. If you do not have an established history on your credit report, don’t despair, you may be able to work a lender through nontraditional or manual underwriting by reviewing how you’ve paid rent, utilities, child support, or other ‘nontraditional’ credit and/or payment histories to demonstrate a positive history.
Delinquent accounts – as part of your credit history, your credit report notates when you pay a bill late (30 days or more). A pattern of late payments can negatively affect the underwriting outcome, particularly if late payments have been recent or on previous mortgage loans. The amount of time since the account was delinquent is also considered. Remember, just because you bring an account current does not mean the credit report drops the notation of delinquency.
Credit Balances Owed – active accounts can be a useful tool to reflect a positive credit history. Nevertheless, use your accounts wisely. The smart consumer knows that if most of their credit accounts are ‘maxed out’ (or close to the credit limit) this may be interpreted by an underwriter as potential credit overextension and increase the risk assessment made. Limit your credit usage activity during the lead up to and during the loan application UNTIL the loan CLOSING is complete. Newly opened loans and credit balances near their limit will also impact your credit score, which can also influence how expensive it is for you to borrow money.
Public Records – If you have not paid your bills over an extended period of time, many creditors will pursue collection or legal action against you. Legal actions including bankruptcy, judgments, liens, or foreclosure are listed on your credit report in the ‘public records’ section. These items will list on your credit report for 7 to 10 years. While public records usually create higher risk determinations, the older the listing, the less influential the negative impact. Some public records (and extreme delinquency – i.e. a mortgage loan 120 days or more delinquent) may ban you from housing finance for 3 – 7 years and some may permanently bar you from some first-time borrowers and down payment assistance programs.
Inquiries – typically, each time you apply for credit, the creditor will request a copy of your credit report. The listing of who has accessed your credit report is known as inquiries. When looking to purchase a home, caution should be used by the smart consumer to carefully control how often the credit report is accessed for a least six months prior to your application for a mortgage. If you want to know what is on your credit report prior to applying for a loan, contact a credit or housing counselor who can assist you with a ‘soft’ pull that does not impact your ‘inquiries’ and likewise does not negatively impact your credit score.
Remember, consistent monitoring of your credit report, particularly the credit report factors, early in your home buying efforts is important. Allowing adequate time to correct any errors and ensuring there will be no surprises as the underwriting review proceeds will reduce any additional stress or anxiety you may have resulting from this life changing experience. Next time, we’ll review the non-credit report factors to increase our understanding of the underwriting process and consider some ideas for strong assessments of those factors as well.