You may not believe this, but lenders actually DO want to approve your loan application. As long as you meet the minimum qualifications for income and credit, you can be confident that your mortgage application will be approved. Keep in mind, however, that there are many steps in the process—and even small mistakes can cause you headaches. Here’s what to keep in mind.
Keep Your Credit Score In Shape
The FICO score is a three-digit number derived from information in your credit report. Engineer William Fair and mathematician Earl Isaac created a financial model in 1956 to help banks identify risk based on borrowers’ previous history. Their firm, originally named Fair, Isaac and Company, became just FICO in 2009.
FICO scores range from 300 to 850. Most borrowers will have three scores—one from each of the three credit bureaus. Lenders use the middle of the three scores in making their loan decisions. If there are two applicants, they will use the lower of the two middle scores.
If you are applying for a conventional loan, you must have a FICO score of at least 620. A government-insured FHA loan requires just 580. Credit reports with these lower scores will typically have late payments, high credit card balances and possibly accounts in collection. If you are in this situation, you should not despair! You can still be approved for a mortgage.
You will have to pay off collection accounts. Collection agencies often agree to negotiate; in some cases, they’ll settle for pennies on the dollar. If you are in this kind of a situation, contacting the collection agency can save you literally thousands of dollars—and put you on the road to a much better credit score. Keep in mind, though, that if a creditor agrees to settle your $4,000 bill for $1,000, they will send you a 1099 at the end of the year for “debt forgiveness.” This means that you’ll have to report the $3,000 as taxable income.
Settling an account like this does not mean that it will disappear from your credit report; its status will change from “collection account” to “paid collection.” Your FICO score may increase a little—but it may not.
If your score is just below the required minimum, you may be able to get over the threshold quickly by reducing credit card balances. Balances that exceed 30% of your credit limit will pull your scores down. Your loan officer can advise you how best to raise your scores by paying down these balances.
Make Sure You Can Track Your Cash
Pay very close attention to this next part.
When you make your offer to the seller, you will attach a check to show you’re serious. This is your Earnest Money Deposit. You will deposit the rest of the funds needed right before escrow closes. You will provide bank statements to the lender. If there are large deposits that aren’t payroll deposits or tax refunds, you’ll have to show where that money came from. This is a “paper trail.”
Be very careful about transferring money. If you moved $1,000 from your savings account to your checking account, you’ll have to provide two months’ statements for the savings account as well as the checking account. You’ll have to paper trail any large deposits to that account, as well.
Banks are meticulous about these deposits because they are concerned about “undisclosed debt.” Under no circumstances should you take a cash advance on a credit card or go to a payday lender to get the money to close your purchase. If you are receiving a gift from a relative, be sure to have a signed gift letter and a bank statement showing the source of the donor’s funds.
If you sell personal property like a car or jewelry, document the sale. Give the buyer a bill of sale and give a copy to the lender. Don’t wait until the last minute to do any of this—do it as early in the process as possible.
Delay Or Prevent Any Job Changes
As a rule, you have to show that you have been doing the same kind of work for at least two years. If you have recently changed employers, you’ll document your history for at least two years. If you recently graduated from college or a trade school and have just started your first job, provide documentation showing your training for the job you now do.
Don’t make significant changes to your employment situation while your loan is in process. Above all, don’t quit your job or retire before your escrow has closed. (Don’t laugh—it has happened.) The lender will call your job right before close of escrow to verify that you still work there.
Don’t Open Other Accounts
One word of advice: DON’T. The lender will use the information from your initial credit report to calculate your debt-to-income ratio. They will perform a “credit refresh” right before completing your loan to see if there are any new accounts since the original report. Buying a new car before closing escrow on your new home could be a deal killer. Put off any major purchases until after you’ve closed your transaction.