Any lender knows that credit, collateral, and character are of the utmost importance in the lending decision. Unfortunately for many people of sterling character, in this day of automation and decision making, credit and collateral have more focus on them, and have become purely a numbers game. In fact one of the biggest issues facing homebuyers today is problems with their credit scores. Available loan products and interest rates will vary significantly with a person's credit score, and loan officers spend a fair amount of time working with borrowers to make sure that their credit score are as high as it can be.
Borrowers are told to make their mortgage payment on time and in no event later than the 30th day of the month. Even one 30 day late mortgage in a year can drop a credit score by 40-50 points and make one ineligible for certain mortgage products. Borrowers should not allow their credit card balances to go above 50% of their maximum credit limits, ideally (for credit score purposes) keeping the balances at 25% of the credit limits.
All minor medical bills should be paid once the insurance company has finalized the person’s share of the bill. Disputed charges are often less than $200, but a Collection Account on a credit report can reduce a credit score by 20-100 points.
A borrower, whether it is a purchase or a refinance, should not take out new debt during the mortgage process without speaking with their lender. This includes car loans, credit cards, etc., and also includes co-signing a loan for a friend or relative. (Co-signing, from a legal perspective, is the same as signing.) Nor should they have too many institutions run their credit report as each credit pull will reduce a credit score by about 5 points.
Many people are involved in the home loan process and lending decision, and it is in everyone’s best interest to keep credit scores as high as possible.
It goes without saying that the reason for applying for a home loan is to have it approved by the lender. But for some borrowers that is the most difficult step. Most “in the biz” agree that the lack of preparation through the pre-qualification process is the primary cause of most delays, or problems, in the loan approval process. When being pre-qualified or pre-approved, there are some common areas of questioning that borrowers should be prepared for, regardless of whether or not it is a QM or a non-QM loan: income, assets, and credit.
The first area of questions involves a borrower’s income. Is there overtime pay, commissions, self-employment income, and if so, for how many years? The basic rule on counting overtime and other income for qualifying is that it must be of a constant and continuing nature and applicant must have received for the past two years.
The second area is regarding assets: does the borrower have enough money for a down payment, closing costs, and reserves? Asset documentation, actually deposit of funds documentation is the number one stumbling block to final loan approval and closing. Generally, any deposit that is not part of employment income will need to be documented. Gift funds, sale of a car, lottery winnings, whatever - any deposit in two months of a borrower’s bank statements prior to application will need explanation and documentation.
The third area is credit. Any issues with credit are usually discovered early in the loan process when the credit report is run, at which point, if there are problems, the lender may help the borrower resolve or rehabilitate their credit.
Every loan is different because every borrower is different and brings their own set of issues to the process. The three main components of mortgage approval for an applicant are income, credit and cash, one of the three is usually the limiting aspect of how much a borrower can qualify to purchase. Knowing what the potential problems and weaknesses are in qualifying are key to a successful and smooth loan process.
The basic process of “doing” a loan is relatively simple: the borrower provides the lender documents proving that they are credit worthy, the lender reviews the documentation and the status of the property (underwriting) to verify that it is a sound risk, and then the money is lent. That being said, the process can take months, with the bulk of it being spent in underwriting the loan.
Underwriting criteria change with time, but one of the standard questions from borrowers is, “If Fannie Mae, Freddie Mac, FHA, or VA allow a certain loan-to-value (LTV), why doesn’t a lender?” Another way of asking this is, “What is a lender overlay?” It is important to understand that underwriting guidelines can vary widely from lender to lender even if the government specifies the criteria.
Basically, lenders have different appetites for risk, along with different specialties, so what one lender will gladly approve another will not. A “lender overlay” is essentially an expanded guideline (or set of guidelines) on top of what Fannie Mae, Freddie Mac, or the FHA/VA will allow. It is important for borrowers to remember that Fannie Mae, Freddie Mac, and the FHA/VA all set underwriting guidelines for residential mortgages but they don’t actually lend money directly to consumers. Individual banks and lenders provide home loans directly to consumers, and often they impose their own rules on top of those “agency guidelines,” and those additional rules or requirements are known as overlays.
Many of the overlays come from a lender’s experience with a type of loan. As an extreme example, if a lender finds out that every loan on white houses above 80% LTV goes into default, the lender will put an overlay on that requires every loan on a white house to be below 80% LTV, even if Fannie Mae and the other agencies will buy loans on houses that are white up to 95%.
Another example is that the FHA (Federal Housing Administration) will accept credit scores as low as 500 as long as you’re able to put 10% down. While this is true as far as the FHA goes, the particular lender you may be speaking with could require a minimum FICO score of 640, 680, or even higher. This is their comfort zone. Perhaps they’ve looked at default data and found that borrowers with scores below 640 happen to miss mortgage payments frequently.
These are just a few examples of lender overlays – there are literally hundreds of overlays required by individual banks and lenders throughout the country. They range from credit score (most common), to max loan-to-value, to max debt-to-income ratio, time after a short sale to borrow money to buy another house, and much more.
Mortgage rates continue to be low – hovering around 3% to 4% for a 30-yr fixed rate mortgage – and borrowers have a renewed interest in seeing if they can refinance. Borrowers across the nation are wondering if it is the right time to buy a home or refinance. Before you apply, be sure you do your homework to ensure it makes sense financially, and to see if you’re actually able to do it. In many areas home prices have fallen and mortgage underwriting has become a lot more stringent, making it especially difficult to get approved for a mortgage.
If your current rate is in the 4% range for a 30-yr fixed rate loan, it may make sense to obtain a 15-yr mortgage in the 3% or lower area. This is especially true if you plan to stay in your home for the long haul. The cost of refinancing has gone up, so spreading this expense over a number of years can make sense – but usually not for someone who is only going to keep their home for a short period. Ask your lender to run the numbers.
Assuming you do decide to refinance, check your credit scores long before you begin the process. If your credit scores aren’t in great shape, you may not be able to qualify. But if your scores are looking good, try your best not to apply for credit cards or any other type of loan, or making big charges on existing lines of credit, as events like that have a negative impact on your credit profile. You should also check your property value. Without equity (the house being worth more than the loans on it) it will be nearly impossible to refinance unless you’re able to take advantage of one of the government programs or bring cash in at closing (cash in refinance).
Other things to keep in mind prior to refinancing are, “Is your property listed for sale?” (It should not be.) Is there a prepayment penalty on your current mortgage? There are other considerations, but give your lender a call – they can help.
Often is the question asked, “What’s up with paying for a property in cash?”, albeit in slightly more technical language. For buyers, the market is tough right now, as there’s not a lot in the way of inventory, and sellers often receive multiple offers, especially in some parts of the nation. Many real estate agents suggest that buyers make a cash offer in order to make themselves seem more competitive and improve their chances of having their offer selected.
Buyers have a few options when it comes to making an offer. They can pony up cash by writing a check and backing it up with statements that disclose the balance of their accounts. They can get pre-approved, which involves having their down payment verified with asset statements; employment verified with W-2 forms, pay stubs, and tax returns; credit reviewed; and loan reviewed for underwriting. They can also be “pre-qualified,” meaning that all of that same documentation has been reviewed but not underwritten.
Trained loan officers tell borrowers that the last option, despite its somewhat reassuring moniker, poses certain risks to a borrower’s deposit. If the buyer puts down 20%, for instance, and the appraisal comes back lower than the price upon which both parties agreed, the buyer is faced with a situation where they have to come up with more money, pay private mortgage insurance, or convince the seller the lower the price.
Such a scenario can become even more complicated if the seller refuses to deviate from that agreed upon price and the buyer doesn’t have that extra money and can’t qualify if they have to pay private mortgage insurance. In this particular case, the buyer could potentially lose the deposit.
Cash payments do indeed make for an attractive buyer, but the wise would-be homeowner understands the difference between a cash offer, being pre-approved, and being pre-qualified along with the risks carried by their various options. Be sure to ask your loan officer their thoughts!
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