Mortgage Qualification Do’s and Don’ts
DEAR BERNICE: We have been saving up to buy our first home. We have a number of credit cards, some with no balance. My brother thinks it would be smart to get rid of those cards that have no balance. He claims it will make it easier for us to qualify for our loan. Is that a good idea? –Amanda S.
DEAR AMANDA: To protect yourself and to determine how much you can qualify for in terms of a loan, order a copy of your credit report. There are three primary credit reporting bureaus: Equifax, Experian and TransUnion (AnnualCreditReport.com is a service created and sponsored by these three bureaus). The law entitles you to have a free copy of your report once per year from each credit bureau.
Be sure to obtain a report from each agency. Some experts suggest that you pull a report from one agency every four months. This allows you to spot problems more quickly than checking all three bureaus at the same time each year.
It’s important to note that the reports may not contain the same information. For example, one of the agencies may report a delinquency that does not appear on the other two agencies’ reports. Also, credit reports are notorious for having errors. Something may have been entered into the database at Experian incorrectly that was correctly reported at Equifax and TransUnion, as an example.
The second option is to seek out a mortgage professional and become preapproved for your loan prior to making an offer on any property. A “preapproval” means that the lender has checked your credit, your employment, and is prepared to make you a loan provided the property appraises at the purchase price and that there are no title insurance issues. The lender will order a copy of your credit report.
In most cases, this is something that you would pay for as part of your normal transaction costs. Lenders cannot use the report(s) that you pull. Going to a lender first allows you to cope with any issues that you may have on your report before applying for a loan.
Your credit report will have what is known as your “FICO” score from the Fair Isaac Corp. This score is based upon a number of factors including payment history, the amount of debt you are carrying, and the type of credit you have obtained. FICO scores range from 350 (poor) to 850 (excellent.) Your credit score determines how much lenders are willing to loan to you.
If your score is above 760, you will probably be able to qualify for some of the best loans with among the lowest interest rates. If your score is below 620, you may have a hard time qualifying for some loans in today’s environment.
This brings us to your question. The credit crunch has created a host of problems for both the real estate and the lending industries. It is harder than ever to qualify for a loan. Furthermore, people who have had perfect credit are now finding that their 800 credit score may have dropped to as low as 625, even though they haven’t made a late payment or done anything else to negatively impact their credit.
A September 2009 article in USA Today outlined what is happening. In a nutshell, assume that you have credit lines that total $50,000 and your current debt owed is $25,000. You have used 50 percent of your available credit. The credit-card companies are aggressively lowering credit lines to limit their risk. If your credit line is lowered from $50,000 to $30,000, instead of using only 50 percent of your credit you’re now at 83 percent of your credit limit.
This, in turn can lead to a lowering of your credit score. In fact, some people have decided to draw out all the money on their credit lines and put it in the bank, just to have it available if they need it.
Some experts suggest that you should never close a credit account because it can negatively influence your debt-to-credit ratio. Others suggest that you charge something each month on each account, but only do so if you can pay it off promptly. It’s better to have a zero balance than to pay hefty late charges. The challenge in this situation is that any debt that you have will be used to calculate how much you can borrow.
The old rule of thumb used to be that your PITI (principal, interest, taxes and insurance) should be 28 to 33 percent of your gross income. The payments on your total debt should not exceed 36 to 40 percent of your gross income. With the E-Z qualifiers (sometimes known as liar loans since no one verified income), those rules went out the window. Now, the lenders are stricter than they have ever been.
Consequently, never buy new furniture, a new car, or make any other major expenditure prior to closing your transaction. The reason is that the lender will check your credit ratios prior to funding the loan. Any increase in your debt could prevent you from qualifying.
Here’s the bottom line: Obtain your preapproval from a reputable lender, leave your existing credit lines in place, and refrain from shopping for all but essential items until your transaction closes.
Bernice Ross, CEO of RealEstateCoach.com, is a national speaker, trainer and author of “Real Estate Dough: Your Recipe for Real Estate Success” and other books. You can reach her at [email protected] and find her on Twitter: @bross
Mortgage Qualification Do’s and Don’ts