You Through the Underwriter’s Eyes — Credit

Credit is super important in financing a home, and these days, even more so.  In my previous blog,  I introduced how underwriters make a loan decision based on four criteria – capacity, credit, cash and collateral.  That blog went over capacity – otherwise known as your income and employment.  Today, we will get to know what role credit plays in your loan decision.

Credit score trumps many things in today’s lending. For instance, you could have sufficient income, plenty of assets (money in the bank), but you don’t have the necessary score set forth by the investor.  Because of this, you might not be eligible for financing until your score meets investor requirements.  These “certain” scores will vary depending on program and lender.  Your individual credit scores are generated through three credit bureaus – Experian, Equifax and TransUnion.  Not everyone has scores and some people may have less than three scores due to a lack of or length of credit history.

As a consumer, you have the right to look at your credit report annually for free. You can visit www.annualcreditreport.com.   Getting your scores will cost you though, so be prepared to pay something to see your scores (costs vary).  A best first step is to visit www.myfico.com to learn from the best!  Your score may be available via other methods, such as your credit card company or outside companies you may pay to monitor your score.

The important thing to know here is that most mortgage lenders use the FICO scoring system, created by Fair Isaac Corporation in the 1950’s (source).  There is another major scoring system called Vantage, established by the three credit bureaus (source).  While Vantage scores are accurate under Vantage, they are not what the majority of lenders use for your score, so they may not be an accurate indicator when it comes to mortgage financing.

To unintentionally confuse matters, BOTH scoring systems pull from the three bureaus, one of which is Experian and their score is actually called a FICO score. Under the Vantage system, your Experian FICO score may be different than the FICO score under the FICO scoring system. Always best to know what system is being used to generate your score, especially since your lender is probably using the FICO system.

We now know score is the starting point, but it’s not the only point. In a previous blog, “No Credit = No Loan” alludes to, you don’t necessarily need a score.  But, we still need to look at your history.  Your score is an indication of how well you pay your bills, how much you use your credit (allowable limits in relation to actual balances), types of credit you have (revolving vs. installment), length of time credit has been established and recent inquiries (credit checks) into your credit.  And by the way, your score is literally a snapshot on the day it was pulled so it could vary daily.

Lenders are trying to determine your willingness and ability to repay the loan. Sometimes the score doesn’t tell the whole story, so they do look at other things.  Have you had any late payments in the last 12 months (may go back 24 months depending on program)?  Are there any outstanding collections or any other major derogatory things like judgments, bankruptcy, foreclosure or short sale?  If you have had one or more of the major derogatory items, the waiting period for new loan will differ depending on the loan program you use.  And guidelines for collection accounts will vary by program too – whether they must be paid or not.

Your monthly debts, items on the report and items not on the report, such as child support, alimony or tax payments, all need to be factored into that you can qualify for. The lender will run ratios, or percentages, to determine your qualifications using your usable/verifiable monthly income in relation to your monthly debts.

As an example, using monthly qualifying income at $5000/month and monthly debts at $650/month, below is how the figures shake out. These ratios are standard guidelines for FHA financing and will differ with other loan types.  The debt piece under credit goes hand in hand with the capacity part – income.

Sometimes, the underwriter also wants to know the “why” behind any derogatory items. What was the reason you had a bankruptcy or late payments on the credit card.  Again, they look at the whole file, as well as guidelines of your loan program, to determine the necessity of explanations.

To sound like a broken record, credit is the utmost importance when it comes to your loan. The advice here is simple: pay your bills on time; keep your balances status quo while in the process and do not close any accounts or open any new accounts.  If you have had derogatory items in your past, a lower score or no credit, start early and get in touch with a lender to discuss what you need to do to be ready for your exciting home-buying journey!   Next up of the 4 C’s – Cash.