Everything you need to know about mortgages
What will banks consider in reviewing my file?
Banks will review your Credit, Income, and Assets. No one factor is determinative, rather the entire financial profile, as well as the condition of the building, is taken into account in determining whether a buyer qualifies for a mortgage and/or what type of loan program is available to him or her.
Credit: It goes without saying that bankruptcy or foreclosures will make it very difficult to obtain financing. Other credit snafus will also negatively impact financing such as carrying a high percentage of debt or having a history of delinquencies. What is a good credit score is changes with the times... above 700 used to be considered excellent, but now many consider that benchmark to be 740. In any event, the importance of good or excellent credit cannot be overstated.
Income: Income is the denominator that can limit the amount of financing. Banks consider an applicant's debt-to-income ratio in determining how much debt they can take on through financing. Debt-to-income ratio is the measure of total debt obligations (the monthly carrying costs of the purchase including mortgage and monthly maintenance/common charges and taxes on the property along with any other mortgages, student loans, outstanding credit card debt) divided by verifiable income. Debt is pretty easy to calculate though it varies from property to property that the buyer is considering. Verifiable income is easy if the applicant(s) have a salaried job, but can be much trickier with self-employed applicant(s). In fact, each bank might have different standards for determining income in these trickier cases, so an applicant's ratio may vary between different lenders. Different lenders and programs vary in the ratio they require: In most cases, on jumbo loans (loans over $625,500), banks will want ratio of 43% or below, but some use expanded criteria and will lend a higher amount. Loans under $625,500 can be obtained with a debt-to-income ratio of up to even 50 percent. There's no magic number, so it's important to consult with your mortgage professional when considering different properties.
Assets: Most banks will want to see some post-closing reserves (mortgage + monthly carrying costs) -- this could be a year's worth, or or 2 months', or 6 months' worth. Some programs may accept retirement assets toward reserves, while other lenders may require the reserves to be liquid to qualify for their lowest rates.
What does all of this mean? There are a huge number of lenders and even more loan programs out there, and even if you are not an ideal candidate, there will likely be a right program out there for you. If one factor is lacking (like income), banks will place greater emphasis on the other factors. It's all a sliding scale, and different lenders and loan programs require different benchmarks. There might even be special circumstances that would justify a loan where the lender's standard analysis would normally result in a rejection (like for example, if you held a great deal of assets in the bank or getting a co-signer).
What do you need to know about your credit score?
Once you've decided to buy a home, or better yet, well-before start thinking about your credit. The earlier you begin monitoring your credit, the more of a positive impact you can make.
1. Not all credit reports are created equal.
Not to dissuade anyone from using any of the free credit report services online, but the best way to check your credit is to obtain a credit report from a mortgage professional. Not all reports are the same, and your score may vary among different agencies. The FICO Risk Score is most likely to be used by lenders and has the most strict criteria. Having a mortgage professional run your credit ensures not only that you are looking at the right report, but they can help you interpret the results and identify any quick fixes that may maximize your score.
2. Evaluate (and change) your spending habits.
To have a good credit score, you have to take on credit. Notwithstanding delinquencies, the longer you've had credit, and the more credit, the better. A few concrete tips: Don't close out credit cards without a good reason (like avoiding an annual fee) and keep credit card balances at or below 30% of the limit. This might mean spending on less on several cards rather than carrying a large balance on a single card, even if you pay it all off each month.
3. Glitches and Fixes.
Reviewing the report also provides an opportunity to correct minor glitches, like a doctor's bill that was eventually paid but was reported to agencies and never remove. Some more major issues may be rehabilitated by engaging a credit repair company, while other major issues (like bankruptcy) may haunt you for up to 10 years.
A collection account, even for a very low amount, can reduce your
How to maximize your credit score/worthiness?
Per our expert, Zack Tolmie, Home Lending Officer at Citi Bank, here are tips on maximizing your credit score. Click here to reach Zack with any questions.
The difference between a 699 and a 700 credit score could mean the difference between getting approved or denied for a mortgage, or the difference of .25% on your mortgage rate. On a $500,000 loan, that’s a difference of over $25,000 in thirty years. Credit scores are critical when it comes to qualifying and getting the best interest rate on a mortgage, so if you’re thinking about buying a home in the future, there are things you should be doing now to ensure your score is the best it can be.
The first step is obtaining your free credit report at www.annualcreditreport.com. Do not worry about or pay for your credit score because the scores available to consumers are completely different than the scores that lenders look at, so the score you see on a consumer report has no value to you or a bank. You can also ask your mortgage banker to pull your credit report. He can pull your report for free and let you know the exact score that lenders would see. You should go through the information in the report and make sure that it does not include any credit accounts that don’t belong to you (identity theft). If there are, call the credit reporting agencies to report this identity theft and have them remove the fraudulent reporting.
Also identify all creditors to whom you owe money. Long-forgotten and outstanding medical bills, parking tickets, or even overdue library late-fees can be sent to collection agencies and reported to your credit report, and can drop your score by upwards of 100 points. Your report will show if the collection account has been paid or not, will tell you which company now owns the debt, and how to contact them. However, once it is on your report, it has done its damage. Paying off the debt will not improve your credit score. What CAN affect the score, though, is if you get it removed. Sometimes, collection agencies will agree to remove the record of your collection if you pay the balance in full (called “pay for delete”). Be sure to get this promise in writing. Whatever you do, DO NOT settle the account for less than is due. This will be an additional tumble to your score. If the company will not remove the record from your report, you may want to contact a credit repair company. These services are expensive, but may be worth it if it can lower your interest rate. Ask your real estate agent or mortgage banker for a recommendation of someone they trust.
Once you’ve fixed any past blunders or mistakes, focus on your account balances. Your debt-utilization-ratio is the percentage of how much credit you use compared to how much you have available to you. To maximize your credit score, you should be using 10% or less of your available credit. This means that if you have a $10,000 credit card limit, you should never have a balance of more than $1,000 on your card. If you have some credit cards that you do not use, do not close them. These unused cards will help offset some of your higher utilized credit cards. If you’re worried you are using too much of available balance, asking for an increase to your credit line may increase your credit score in the long run.
However, opening new accounts will hurt your score in the short-term. Do not apply for any credit cards, line increases, personal loans, or car loans in the three-month period leading up to a mortgage transaction. Obtaining new debt, and even applying for new debt, will hurt your score temporarily. The credit score algorithm takes into consideration that borrowers will call several banks when shopping for a mortgage rate, so you can feel free to call as many banks as you’d like. However, keep these inquiries to a period of a few weeks. Do not call Bank A in July, Bank B in September, and then Bank C in November.
The final determinant of your credit score is the most obvious, and it has a bigger effect on your score than anything else: pay your bills on time. It accounts for 35% of your score. Set-up automatic bill payments online if you’re the type to forget to make payments. Neither the credit reporting model nor banks care that you have a bank account filled with money if you can’t move some of that money once a month to pay your bills. Pay credit card bills once a week if you have to. It will make sure you’re never late, and it will also keep your debt-utilization-ratio low.
Credit scores can be confusing, but in the end, they are intuitive. Keep track of your debt. Don’t max out your debt. Don’t apply for too much debt. Pay your debt. Creditors update their reports to credit reporting agencies once a month, so making any of these improvements might only take a few weeks to improve your score.
Common Mortgage Misconceptions Debunked by our Mortgage Expert, Zack Tolmie
1) I have a lot of student debt. That means I can't qualify for a mortgage, right?
Interestingly, banks aren’t concerned about the amount of debt you have. We care instead about your monthly debt payments. As long as you can afford to make your mortgage payment and your student loan payments, the amount of your student debt shouldn’t impact your ability to qualify.
2) I read that the Fed just raised/lowered rates, this means that mortgage rates are going to go up/down, right?
Not necessarily. The Fed forecasts well in advance when they expect to change rates. Banks proactively update their rates based on these forecasts. By the time that the Fed finally makes the change, mortgage rates have already been updated well in advance. During the Fed rate decrease/increase announcement, banks are already thinking ahead to the next anticipated rate change by the Fed.
3) I heard that the housing crash in 2008 was because lots of people did adjustable rate and interest-only loans. These are never a good idea or responsible choice, so I should not consider them, right?
An adjustable rate or an interest-only loan might be worth considering if you know you will not own the property for a long time, or if you know that you’ll pay off the mortgage very quickly. These kinds of loans have lower monthly payments for the first 5-10 years. After that, the payments could increase substantially. Prior to 2008, borrowers weren’t always aware that payments could jump. It ended in disaster when homeowner’s couldn’t afford their new payment. If you know you’ll be long gone by the time the payment adjusts, you might want to discuss one of these options. But if you think there is a good chance that you’ll have the mortgage for a long time, a fixed rate is definitely the safest bet.
4) I shouldn't rate shop or consult with multiple lenders (or go to a lender before I'm ready) because when they pull my credit, it will lower my credit score.
I work for a bank, and I still called a dozen banks before locking my rate for my mortgage. I wanted the lowest rate possible. Having a mortgage lender check your credit has a negligible effect on your credit score (it’s having multiple banks pull your credit for a credit card application that really hurts your score). If you call several mortgage lenders within a short period of time and have them pull your credit, it will only affect your credit score as if one single lender made a credit inquiry. So, get your rate shopping done in the same calendar month. But don’t avoid shopping for the best rate.
5) Do most loans have a prepayment penalty? What happens if I prepay part of my principal at some point?
No, prepayment penalties are incredibly rare. If you make a prepayment (for most loans), your mortgage payment won’t go down. Instead, you’ll pay off the loan faster and shorten the term of the loan. For example, instead of having a payment of $2,000/month for 30 years, you’ll have the same $2,000/month payment for just 20 years. By prepaying, more of your payment each month will be applied toward lowering your principal balance, and less will be spent on interest. You save in time and interest.
Some banks give you an additional option to recast your loan. By recasting, your term stays the same, but your payment goes down. So instead of having the payment of $2,000 for 30 years, you’d have a payment of $1,500 for 30 years. In recasting, you save in cash flow and interest.
6) I already identified my property, put in an application, and got a loan commitment. But my commitment says it expires on X date. What happens if I can't close by then?
Nothing to stress about here. Your paystubs, bank statements, and credit report have a “shelf life” of about four months. After four months, you’ll need to update your paystubs or bank statements, or have your credit pulled again. Once we’ve updated those items, we can update the commitment letter.
Zack Tolmie is a home lending officer at CitiBank, previously vice president of mortgage lending at Guaranteed Rate. Thank you Zack for answering our questions this week!
How can I make sure my mortgage is approved?
1. Keep your finances SIMPLE for 2-3 months prior to applying
This seems obvious but might be more complicated than you think. When you first apply, the bank will look at you last 2-3 months of statements. Any large withdrawals, deposits, or “interesting” activity is cause for concern on their part – even if you just loaned a friend money, or went on an extravagant vacation. Any unusual spending patterns, no matter how explainable, can complicate the process. Other things, like applying for a new credit card or having your credit run, will affect your credit score for around 6 months.
2. Minimize your liabilities
Did you cosign a loan for a friend or relative? Are you still on your old lease a year after moving in with your significant other because it was easier to just let your roommates cousin move in unofficially and sublet your room? Did you apply for a new credit card and buy all your Christmas gifts on Amazon to get frequent flier miles for that awesome trip to Aruba in January, but plan to pay it all off next month? Is your name still on that joint credit account with your sister that your parents set up when you were in college, where she has now racked up to $6,000 of debt? These things may sound trivial, and are not expenses you actually expect to have to pay, but in the calculating eyes of an underwriter, any debts, notes, or accounts you have a legal obligation to, whether or not you are the one paying them in practice, will be considered a liability and can ultimately bring down the size of loan you can qualify for. This includes and leases, loans, credit cards, and any other accounts payable that your name is attached to.
3. Be BORING during underwriting
Keep your finances as boring and steady as possible between the time you apply for a mortgage and the time you close on the loan. That sounds simple in theory, but it's sometimes difficult in practice. However, the reason behind it is simple: when you apply for the mortgage, the lender looks at your credit report and your credit score. Then, shortly before closing, the lender will survey your credit again. If there's a substantial change of any kind, the lender might have to delay your mortgage closing. Which brings us to #4…
4. Don’t apply for a new credit card or loan
Mortgage lenders always caution mortgage applicants to avoid getting new credit cards or auto loans while home loans are in underwriting. Remember that your credit debt (liabilities), not just your credit score, are used to determine what monthly loan payments you are able to qualify for – the more debt you have, the higher your expected monthly expenses become. Assume that everything you do will be examined up until the minute of underwriting and spend/behave accordingly.
5. Don’t change jobs
Getting a new job, or a new position with a different pay structure at your same employer, may jeopardize your mortgage. This is especially the case where your income from salary is decreased, even if you ultimately expect a bigger pay day with commission or bonuses.
Finally, a disclaimer: I'm no mortgage expert, but I know a few. An experienced mortgage banker is the best (really, only) person to advise you properly on your specific financing options, and they should be on speed dial as soon as you decide to you want to buy a home. Once they review your mortgage application, run your credit, and verify the information via the underlying financial documents, such as tax returns, paystubs, bank/brokerage/retirement plan statements, canceled rent checks, any other proof of assets or explanation for recent large deposits, they will be able to advise you on how to finance your home.