MANAGING YOUR CREDIT WISELY
Whether you're a first-time buyer or a seasoned homeowner looking to move up to a bigger or better house, how you have managed your consumer credit rating can have a real impact on both the amount and terms of your next mortgage.
Naturally, if you have kept your credit use reasonable and consistently paid your bills on time, you will most likely have few difficulties obtaining a mortgage loan. But what if you are one of the many Americans whose credit report is less than perfect?
Contrary to popular belief
It is not impossible to obtain a mortgage with an imperfect credit rating. After all, mortgage lenders are in the business of providing loans, and have it in their interest as well as yours to find an appropriate way to finance your home purchase. Credit Doesn't Necessarily Have to Be “Perfect” to Be Good In the case of a single bad mark on an otherwise good credit history, many mortgage lenders will simply ask for a written explanation of the late payment. If the explanation is reasonable and believable, many lenders will overlook the isolated problem-especially if it occurred some time ago and your credit has been good since.
As far as lenders are concerned
The most important time period in your credit history is the preceding year or two. According to guidelines established by the Federal National Mortgage Association (Fannie Mae), indicators of good credit do include some leeway for occasional late payments. Thus lenders will look at: Revolving credit (e.g., credit cards), which should show no payments 60 days or more late and no more than two payments 30 days late; Installment credit (e.g., an auto loan), which should show no payments 60 days or more late and no more than one payment 30 days late; Housing payments (e.g., mortgage or rent), which should-not surprisingly-show no late payments (this can be proven by the payment history from a mortgage lender or by the borrower's canceled checks for the past 12 months).
Credit Scoring Broadens Scope of Lenders' Considerations
As credit scoring in mortgage loan decisions has become more sophisticated, lenders have also begun looking at other factors in your credit history as well. They might be concerned if your credit cards are “maxed out” (indicating possible future difficulties in managing debt and making payments) or, conversely, if you have large lines of credit available (that you could at some future time run up unmanageable debt).
Some lenders will also look at how many inquiries have been made into your credit report recently, interpreting several inquiries as a sign that you recently applied for a large amount of credit. Applying for numerous lines of credit might indicate that you have been turned down by other lenders or that you are in the process of accumulating new credit accounts which might leave you with too much credit available to be a good credit risk.
Compensating Factors Can Make a Difference
Credit scoring can also work to your benefit, helping to overcome potential problems like a high debt-to-income ratio or a slightly imperfect credit past. Scoring also considers “compensating factors” that Fannie Mae guidelines indicate might justify some degree of risk to the lender. These compensating factors include: A large down payment; An energy-efficient property (e.g., with up-to-date heating and power systems); Previous large housing payments (such as high rent), which show the borrower's ability to channel a larger-than-normal proportion of income to payments;
Good Credit History
A history of good credit and the potential to accumulate savings in the future (despite a current low net worth); The likelihood of career advancement and earnings increases due to strong education or job training (this is particularly helpful to young borrowers who carry student loan debt); A substantial net worth (despite current low earnings).
Knowing the Factors
Knowing about these compensating factors-and which of them are at play in your own situation-can help you to get the loan you need for the home you really want. But you also need to know what your credit history looks like on paper to be able to optimize your borrowing ability. For example, you may have cut up a credit card years ago, but never bothered to actually close the account.
This account shows up on your credit report as available credit, which lenders may think adds to your risk. The time to close this unused and unnecessary account is before you apply for a mortgage. In addition, you will want to be confident the information in your credit report is accurate. Errors in your credit report-or, worse, the damage done by credit or identity fraud-can seriously impact mortgage lenders' likelihood of offering you a loan. Many financial planning experts recommend checking your credit report on a regular basis in order to keep tabs on the information placed on it.
Reviewing Your Credit Report Puts You In Control
One way to simplify the process of regularly checking your credit report is to sign up for a credit monitoring service. ConsumerInfo.Com offers you a free credit report with a free 30-day trial of their CreditCheck Monitoring Service. Membership includes unlimited free credit reports each year and monthly online monitoring alerts with information about changes to your credit file.
The ConsumerInfo.Com web site also contains a wealth of credit-related articles and information to help you understand and manage this aspect of your personal finances. The information provided by your credit report can be invaluable in understanding your credit rating as mortgage lenders see it, enabling you to correct inaccuracies and know best how to present your correct credit history and circumstances in order to get the mortgage you seek.
The Difference Between Pre-Approved and Pre-Qualified
Some home buyers think getting pre-qualified is the same thing as getting pre-approved when in fact they are quite different. While definitions change in the market, below are general descriptions of what each process entails.
Getting pre-qualified is simply getting an idea of the price range you can afford. It is based on your stated income, assets, and liabilities. With a pre-qualification, your information is not verified and the loan your pre-qualified for is not guaranteed.
During the pre-approval process is when the information you provide a lender is verified. There are two phases of the Pre-Approval process. In the first phase you give your lender permission to obtain your credit report. Your credit report will often confirm the information you provided them about debts, your employer and how long you have lived at your current address. It will also give them your credit score, or your credit rating. If the credit score falls within the acceptable range for the program that you're interested in, you become pre-approved.
If your credit score is too low for your preferred loan program, your lender will discuss your credit report with you. Some erroneous information on the report that can be removed to improve your rating, or perhaps you have a situation that the lender will allow an exception. If you don't qualify for a particular program, there may be another program that best fits your situation; your lender is there to help you work through this process and find the right loan for you.
Once this phase is completed, most lenders consider you pre-approved for a home loan. This extra step solidifies how much home you can purchase, and strengthens your negotiation power with realtors and sellers.
Most lenders require a small fee to apply for a loan, which is typically used to cover the cost of the appraisal and credit report. You will pay this fee up front because the lender has to obtain an appraisal in order to approve your loan. Regardless, if you decide to go through with the loan and purchase the property, the lender has to pay the appraiser and the costs to obtain your credit report.
Approval Final approval is when you have found your home, it has been appraised, the title report has been received and everything has been found to be acceptable to the lender. Once you receive final approval, you're ready to close.