How Do I Get A Loan Approval? Credit,Capacity,Collateral
Education Reduces Risk
Whether you are getting ready to purchase a new home or are looking to refinance your existing home, the process of obtaining financing for your home mortgage needs can seem overwhelming. There are many stories on how obtaining home financing has become much more difficult for borrowers and how lenders have become more reluctant to give a loan approval.
In reality, lending has just returned to past documentation requirements and better mortgage loans are being made for both consumers and investors. Government Sponsored Entities (GSE’s) like Fannie Mae, Freddie Mac, FHA, VA and USDA are constantly reviewing their guidelines in an attempt to create more opportunities to support sustainable homeownership.
Understanding what lenders are tasked with reviewing in making their decision of whether or not to approve a request for a mortgage loan will help you be prepared to answer the many questions asked during the loan approval process.
While mortgage lending may seem intimidating, it is not rocket science. While there may be additional scrutiny needed for those with unique qualifying circumstances, the standard mortgage review process for any type of mortgage loan remains consistent.
Understanding the three “C’s” of lending will help you prepare for the home financing process and give you the opportunity to work on any areas of concern leading you to the most favorable terms available. The three “C’s” of lending are Credit, Capacity and Collateral. We will review each of these topics individually.
This is one of the most important areas to get a handle on as early as possible. Your efforts to correct or improve this aspect of your profile may take as much as 60 to 90 days to be reflective on your credit report. When preparing to finance your home, be sure not to open any new credit accounts and be sure all existing accounts are paid on time.
While perfect credit is not a requirement in order to obtain home financing, efforts made here can pay off in spades. The overall costs for borrowing and/or mortgage insurance vary greatly based solely on your qualifying credit score.
Lenders will determine your qualifying credit score by obtaining a Tri-Merge credit report. This is simply a credit report with three repository institutions (credit bureaus) information. These are typically Experian, Equifax and TransUnion.
The lender will review the three scores provided and use the middle score (Example: Experian 625, Equifax 720, TransUnion 700; Qualifying score is 700). They will do this for any person who will be used for qualifying for financing. If more than one borrowers is present, the lender will use the lower qualifying score of any applicant involved.
The lender will also review the overall report to look for any adverse credit circumstances that may need further consideration. They will be looking for Collection Accounts, Charge-Off Accounts, Disputed Trade Lines, Judgements, Bankruptcies, Foreclosure’s/Short Sales and overall payment patterns to comply with the intended investors underwriting requirements.
The good news is that perfect credit is not a requirement. Life happens. All of these potential “problems” can be documented or explained and the lending process can be resumed.
Of all of the circumstances listed above, one of the more difficult issues to work through is disputed trade lines. When a creditor reports to the credit bureaus that their reporting of the trade line is in dispute, that trade line is removed from consideration in the overall credit score until the dispute is resolved. This may cause the lender to be unable to rely on the reported credit score and determine a valid qualifying credit score for use in financing.
A frequent request from the lender is to have the disputed information removed if it was reported incorrectly or to have the dispute reflected as resolved by the creditor and a new credit report obtained without the active dispute displayed. This will insure that the trade line was considered in the score provided by the credit bureau.
The good news is that not all disputes must be removed. Trade lines in dispute with a zero balance or a balance less than $500 and over 24 months old may remain.
Another important thing to understand is what the credit bureaus will use in determining the score they will provide. Here is a link to helpful tips in managing credit. Some simple steps taken now can quickly lead to increasing your qualifying credit score.
Capacity consists of Income, Debts and Assets. Income used by the lender for qualifying purposes may include or exclude variable types of income such as Overtime, Bonus or Commission income. What the lender is looking for is consistency and likelihood of continuance for the income used for qualifying, the monthly amounts of obligations required to pay all debts and sufficient assets available to cover any down payment and closing costs required for the transaction requested.
In General, the lender will be reviewing your gross income earnings (before taxes). The income review process may be a little different for borrowers who are self-employed or paid on a Commission only basis. Communication is the key here. Be sure to let your lender know of any anticipated leaves of absences or changes in employment status as early as possible. While an absence for something like maternity leave would not prevent you from obtaining financing, it may change the allowable income for consideration for underwriting purposes.
Once all of your allowable income for underwriting purposes has been established, the lender will review the overall debt obligations consisting of all miscellaneous debts and the proposed mortgage payment (Principle, Interest, Taxes, Insurance, Mortgage Insurance and Homeowners Association Fees) to determine a Debt to Income Ratio. This ratio may affect which loan products may be available to meet your home financing needs. For example, FHA financing will allow a higher debt ratio than a standard conventional loan.
The next item to be reviewed in this category is assets. The lender must identify the source of all funds to be used to satisfy the required down payment and closing costs involved in the transaction. Some types of acceptable sources of monies needed for home financing may be personal savings, checking, retirement accounts, gift funds from a family member, seller credits and/or lender credits. Cash deposits can be very difficult to work with.
In general, the lender will request the most recent two months of statements for any assets to be considered in the transaction evidencing sufficient funds for closing. The statements will be reviewed to look for any out of place deposits (such as large cash deposits or deposits not identified as employment income). The purpose of this is to make sure that all debts are properly documented and that no new loans have been obtained that may affect your ability to make the proposed mortgage payment. They will also look through the withdrawals on the accounts to identify the same (such as an IRS payment on the bank statements that is not reflected on the credit report).
This aspect of your request will be answered through the appraisal process. Once the appraised value of the property being financed is obtained, the lender will be able to establish the maximum loan amounts allowable for the financing program being used. This is what is referred to as the Loan to Value ratio.
In a purchase transaction, the loan to value ratio is obtained by dividing the loan amount but the lower of the appraised value or sales price. On a refinance transaction, the loan to value ratio is obtained by dividing the loan amount by the appraised value.
The appraisal will also be used to confirm the condition of the home meets lending guidelines. In general, there may be no active health and safety issues with the subject property (such as exposed wiring, non-operating heat source, uncorrected water damage, etc..).
It is important to know that an appraiser most likely will not be a licensed contractor. They may be unable to identify all potential problems with the overall condition of the property but will be able to identify most of the items that the lender will be concerned about. While it is not necessarily a requirement to have a home inspection to satisfy lending requirements, it is my belief that this is a very important report to obtain.
The home inspection report may not need to be shared with the lender but will provide you with some assurance that a major defect is not being overlooked. Since some repairs can run into the thousands of dollars to correct, the costs of a home inspection is money well spent.
Below is a list of the standard documentation needed by a lender to provide you with the most accurate review of your request. Remember that the more work that is done at the beginning of the process, the better overall experience you will have.
This will also help prevent last minute “issues” that may delay or prevent your transaction for moving forward. If you are purchasing a home and not refinancing, I would strongly suggest that all of these items be supplied and reviewed before granting any weight to an approval letter you may have received.
- Most Recent Two Years Complete Personal and Business Tax Returns
- Most Recent Two Years W2’s and/or 1099’s
- Most Recent 30 Days Pay Stubs and/or Pension and Social Security Award Letters
- Most Recent Two Months Bank Statements (or Most Recent Quarterly Statement)