When you have finally decided to buy a house, approaching the mortgage lender could be a make or break situation. Lenders will go through a process of credit analysis using your credit report and other financial information before they could decide to grant you a loan and on what terms.
Therefore, it is important for you to know how mortgage lenders determine your creditworthiness so that you may prepare yourself for such scrutiny.
What Do Mortgage Lenders Look for in a Credit Report?
Lenders will need more information about you in order to give you a pre-approval. In this case, your lender will make a hard pull on your credit report to look for pertinent data about you and determine the best loan program to offer you.
Here are the things they look for in your credit report:
They want to know if you’ve recently applied for a loan or the number of times you’ve made hard inquiries. Too many of these indicate that you may be in financial trouble.
They look for details indicating that you’re a responsible borrower with no missed or late payments. When they see one, they may ask you for some explanation.
This is an important factor for mortgage lenders, as this indicates how much of your available credit you are using. If your credit utilization is more than 30% at any given time, it’s a sign for the lenders that you’re a risky borrower.
These are likewise red flags to the lenders, especially when they see records of bankruptcies, foreclosures, repossessions, charged-off loans, accounts in collections, court judgments, and delinquent accounts.
Being an Authorized User
Unless you, as an authorized user of someone else’s credit account, are responsible for managing an account, this information will have less weight on their analysis. They would prefer to see how well you manage your own credit card accounts.
A Dispute Statement
Pending dispute information that is currently in your report will obstruct your mortgage underwriting process. Lenders will not be able to see the true view of your credit until your pending dispute is resolved.
Lenders want to know how stable your income is. If you have a stream of income from different sources, lenders would want to know what they are and how frequently you receive them. Knowing all of these will help them determine your debt-to-income ratio, which is also a critical factor for them.
Your list of assets, specifically when it includes high-value assets, will let lenders know how equipped you are in making a larger down payment.
Putting down a sizable amount as collateral tells the lender that you are sharing the risk involved in making the loan. A 20% down payment will also help you get the best mortgage loan rate. But if you are eligible for a federal-backed loan, you may only be required a considerable low down payment, usually ranging from 0% – 35%.
Your Credit History
Lenders typically require 12 – 18 months of positive credit history that shows modest balances and prompt payments across all your credit accounts.
How Lenders Use Your Credit Score to Evaluate Your Mortgage Loan?
Having the right credit score is crucial when applying for a mortgage loan, as your interest rates and monthly payments will be based on that. Having a low score, even if you qualify for the loan, can cost you more money for the duration of the mortgage.
FICO scores are the credit scores most mortgage lenders use to analyze your credit risk and the interest charge that will be applied to your loan. You have three FICO scores in each of the credit bureaus, and they all differ in number because:
- The credit bureaus use different proprietary scoring systems
- They have different ways of gathering credit information from lenders, merchants and other businesses you deal with
- Lenders and merchants are not required to send your credit and transaction information to all credit bureaus, and they could choose which bureau they would only submit. This will cause different overall credit reports, thus further resulting in varying credit scores from the three credit bureaus.
For a conventional mortgage loan, the minimum FICO credit score required is within the range of 620 – 640.
The table below gives you a safe estimate of the mortgage rate based on your current credit score.
|If your FICO® score is…||Your interest rate is…|
|760 – 850||2.74%|
|700 – 759||2.97%|
|680 – 699||3.14%|
|660 – 679||3.36%|
|640 – 659||3.79%|
|620 – 639||4.33%|
How to Prepare Yourself for a Mortgage Loan?
Applying for a mortgage loan is a tedious process — from preparing for thorough credit analysis by the lenders to selecting the best lender for your goals.
To optimize your time and other resources, it is best to start your mortgage plans with a good amount of preparation.
Be Specific and Realistic
You need to manage your excitement in planning on buying a house so you can stay realistic with just how much you can afford. Your chances of getting a good rate are when you have a good credit score coupled with at last 20% down payment. If you are only capable of less than that percentage, make some calculations of the monthly payments based on the interest you’ll be able to get and see if this is something you can keep up to pay long term. Make use of free mortgage loan calculators available online to make your estimates.
Get Your Credit Report in Order
You are entitled to a free credit report from the three credit bureaus every 12 months. Use this opportunity to look for erroneous information in your report that should not be there. If there are any errors, file for dispute right away because the calculation of your credit score is based on what’s in your credit report. Likewise, it takes a while before a dispute gets resolved thereby dragging your loan application plans.
Pre-Qualify for the Mortgage Loan
Pre-qualifying for a mortgage is quick, easy, and can be done online. It involves making a loan inquiry from different lenders without them making a hard pull on your credit report. You provide your prospective lender with some financial information about you – income, current debts, and assets – and they will review these to provide you with an estimate of how much you can borrow and some mortgage options. However, since pre-qualifying for a loan does not involve a complete analysis of your credit report, it does not mean you are pre-approved. Nevertheless, this is a good way to collect some figures, along with loan terms and conditions, for your further study.
Prepare Your Down Payment
The more money you put down upfront, the less monthly payments you have to pay for the duration of the loan. Determine which among your current assets can be used or liquidated to make up a good amount of collateral.
Decide How You’re Going to Pay
You shouldn’t be struggling to make ends meet even if you can keep up with your mortgage payments. There still should be enough money left to go about comfortably in your life. In this area of your planning, make a list of life events that you want to pursue within the 15, 20, or 30-year period that could negatively impact your finances and figure out how you will shield your mortgage loan from that possibility.
Finally buying a home and getting approved for a mortgage loan will feel very much of personal achievement. But with 15 to 20 years binding contracts down the line, it’s not always easy to predict financial stability or which direction your finances may go. It is important, therefore, to keep a realistic perspective and make careful thought on this major decision — so as not to risk losing the home you have always dreamed of to a possible foreclosure in the future.