There are common issues that create difficulties for prospective borrowers. Recognizing these issues can be the difference between getting approved for a mortgage or not. It can also be the difference between getting a better rate or having a wider choice of products, rather than being limited to more restrictive products and higher rates and fees. In no particular order, these are the major themes:
Having a strong credit score
Credit is one of the four components that are critical for underwriting analysis. The other three are: income, assets, and collateral (i.e. the property itself).
1. Having an established credit history is essential to qualifying for a mortgage.
If you don’t have an established credit history, you should begin to build one immediately. You can start by opening up at least two credit cards (not store cards, but rather a VISA, MasterCard, Discover, or American Express) and begin spending on them right away. Be sure to pay at least the minimum required each month. It will take several months to build credit.
2. Having no credit does not mean you cannot get a loan.
There are options for clients who do not have any established credit history. Those options are very limited, and the product choices are restricted with higher rates and fees.
However, if you have at least four items of credit including 12 months of cable bills, utility bills, cell phone bills and even monthly gym membership payments, as well as rental history, then you should be able to qualify for an “alternative” credit loan. This is also true for foreign nationals (i.e., no U.S. residency at all) with no established U.S. credit history. We can still make use of these credit instruments from their home country.
3. Your credit score does not need to be in the 800s to get the best rate.
There are “compensating factors” for the additional risk brought about by a lower credit score. For example, a lower financing percentage can offset the effects of a lower credit score. So if your credit score is 700 (i.e., the low end of tier 3 credit), but you are putting down 30-40 percent of the purchase price, then your rate may still be among the highest available in the market due to the increased equity you will have in the purchase.
4. Each credit pull will not necessarily impact your credit score.
The credit bureaus realize that you are shopping for a mortgage, and all credit pulls within a 3-4 week period are generally counted as one pull. Keep in mind that your credit is a critical component for obtaining a prequalification letter or pre-approval. Every bank will still need to layer in your liabilities from the credit report to determine how much debt you already carry, and therefore how much financing you can get. The credit piece is necessarily proprietary and cannot be used from another lender or provided by you for a formal pre-approval letter.
5. Do not open or close any credit accounts.
People often think that if they close older or infrequently used accounts, and consolidate their credit that they will improve their credit score. In fact, the opposite is true. Your best bet is usually to do nothing that will materially change your credit situation. The longer the history, particularly if it’s consistent and good, the higher your score will be. If you add a new item of credit, there will usually be a probationary period of monitoring to ensure that you can pay the balance on time.
1. Self-employed borrowers have a more complicated review
Self-employed borrowers must generally have a complete two-year history to qualify for a conventional loan. If someone started their business in July of 2013, then they will need to wait until July of 2015 in order to meet the full two-year requirement. Self-employed borrowers also tend to focus on their gross receipts, or on the potential business that they anticipate in the coming months and years.
2. Bonus or commission income requires a two-year history as well.
Bonus or commission income is viewed similarly to self-employment income. There must be a two-year history of receipt (with the same employer) and the income is either averaged or the most recent year is used depending on whether that income increased or decreased over the last two years.
Get your assets in order
1. Reserves are almost always necessary.
Reserves are additional assets needed beyond the funds for down payment and closing costs. They can range from two months of a full payment (principle, interest, taxes, insurance, etc.) to a year or more depending on the loan size. The perfect assets to use for reserves are retirement funds (i.e. 401k, IRA, SEP, etc.) because these are funds not usually liquidated to be applied against reserves which don’t actually need to be paid.
2. Gift assets can be used towards income, with limitations.
If you don’t have sufficient funds to make up the down payment, closing costs and reserves then a gift from a blood relative or spouse is usually permitted (not for investment purchases). If at all possible, try to obtain this gift well before the loan application is started (at least three months). Banks will look at the most recent two months of bank statements (as well as the statement of the month in which the down payment is made and all subsequent months). So if the starting balance of the earliest bank statement already includes the gift, then the additional documentation is not needed.
3. Use bank accounts that have little activity, if possible.
Large deposits have become a hot-button issue for lenders. If deposits (other than salary) such as loose checks or ATM deposits that exceed 25-50 percent of monthly income appear on a monthly bank statement, then they need to be sourced and explained. You can avoid a lot of unnecessary documentation if you can hold off on making those deposits, or deposit them into an account that is not necessary for you to qualify, OR deposit them well in advance (three months) prior to starting your loan application.
If you’re thinking about leaving your job for another firm, don’t do it unless you’ll have at least a full month’s worth of salary before you expect to close. Keep in mind that if you are relying on bonus or commission income, you can completely blow up your mortgage loan process unless you wait until after you close to switch jobs. Remember that none of the bonus or commission income from a new employer will be included in the income determination since you need a two-year history from your current employer.
There are lots of ways I’ve outlined here that you can improve your situation before you even begin your mortgage process.
No one lives according to underwriting guidelines. However, if you’re going to be asking a lender for hundreds of thousands of dollars, you will need to conform to their rules of documentation during your home purchase process.
After you’ve closed, feel free to switch jobs or deposit loose checks or open a new credit card. Just try not to do any of those things when you’re shopping for a home. It will save you lots of time and effort, and it may just make the difference between getting approved or declined for a mortgage.
Shaun Meller has been in the mortgage lending industry since 2002, having worked for JPMorgan Chase and Bank of America, and he is currently a Senior Vice President with The Federal Savings Bank. Over his tenure in the industry, Shaun has closed over $500 million in loan fundings to-date. He is also a qualified New York State Real Estate Instructor, and he has taught continuing education to hundreds of real estate professionals and attorneys. He can be reached at (646) 568-3626.
By Shaun Meller