Lesson 10: Credit For Mortgage Approval

Summary:

There is a lot of work you should do before you attempt to buy (or build) a home
Begin by knowing your Mortgage Middle Score (the median score of FICO® 2, 4 & 5), which is available on myFICO.com
Automated Underwriting (AU) is the process of entering your application into a computer where it reviews the transaction and your credit history to either “Approve” or “Refer” it to a human underwriter for further review
You want an AU approval because it makes the process simple and has a higher chance of closing on-time at the lowest interest rate
There are several low or actually ZERO Down loans still available, even without perfect credit
Most first-time homebuyers will qualify for a program that requires 5% or less down payment
Even with no credit or bad credit, you could still qualify for a mortgage with 10% down
Always ask a mortgage professional what the best course of action is for you

Wise Credit Management is a free Bible-based class that teaches how credit really works by showing factual information directly from the Credit Bureaus and FICO, and simplifies the subject to show everyone how to build good credit or handle bad credit. The class is fairly comprehensive and focused on getting good credit to qualify for a good mortgage rate and terms. WiseCreditManagement.com is a free community for members to take the class, join local groups (online or in person) for mutual support, and to find local professionals who volunteer to use their skills to assist members to success.

Home ownership is the way most Americans build wealth and a lack of education about credit is a huge contributor to the growing “Wealth Gap” in our country. Wise Credit Management is focused on teaching how to get good credit and qualify for a good mortgage rate and terms.

I am not a lawyer or Credit Repair Organization.

My work is protected by the “fair use” section of the U.S. Copyright Act.

Proverbs 24:27 ~ Complete your outdoor work and prepare your field; after that you may build your house.~

In King Solomon’s time most people were to some extent farmers and agricultural to feed themselves. Today we don’t have to prepare our field, but we do need to put in the work to have a good job and be in a good financial position to own a home. Before you start thinking about building or buying your home, make sure you have a stable and reliable source of income and your other obligations are taken care of.

What credit score do you need to get qualified for a mortgage? Ideally you want to have over a 760 to 780 mortgage FICO® (2, 4 & 5) middle score (depending on the lender’s requirements). However, if you have 10% down you can qualify for an FHA loan with as low as a 500 credit score. So, the answer is between 500 and 850, or you could qualify if you have no mortgage score.

What difference will having a good credit score make? Lenders charge a higher interest rate based on your credit score because they are good indications of the likelihood of default. The higher your credit score, the lower the interest rate on your mortgage. The difference between the interest rate charged on a 760 credit score mortgage and a 580 credit score mortgage could be 2% (many other factors affect interest rates). The difference between having a 580 credit score and a 760 credit score could be as much as $100 per month in interest for each $100,000 that you borrow on a mortgage. That means the difference between having a good credit score and the lowest approvable credit score could be about $300 per month on the average mortgage of about $300,000.

What is a mortgage middle score? FICO® Scores (2, 4 & 5) are calculated based on your credit report from each of the major credit bureaus. A mortgage FICO® Score is the specific algorithm intended to calculate the risk of defaulting on a mortgage. The algorithm for Experian is FICO 2, TransUnion uses FICO 4 and Equifax uses FICO 5. Your middle score is simply the middle of those 3 scores.

How can I get my mortgage FICO® Scores? myFICO.com shows your actual FICO® scores from each bureau, including your Mortgage FICO scores. I strongly suggest you use this service to monitor your mortgage scores if you are considering buying a home in the next 6 months. You should at least know what your FICO® Mortgage scores (from the FICO® Models 2, 4 and 5) are before you apply. It’s like paying a $30 pre-application fee.

Which co-borrower’s mortgage FICO® middle score would you use? When there are co-borrowers, the borrower with the lowest middle score will be used.

Are there mortgage professionals who work with First Time Home Buyers (FTHB)? Yes! The mortgage professionals who sponsor this class are specifically announcing they will work with our members who are FTHB or have credit problems. Our Professional Members believe in what we are doing to improve our situations and they are definitely willing to work with you. Many times professionals tend to avoid borrowers where extra work is needed, but our Professional Members are willing to help in any way they can.

Do different mortgage companies have different qualifications? Absolutely! Many mortgage lenders have “Overlays” which are basically additional requirements on top of the minimum requirements to qualify for the loan. For example, the minimum requirement for an FHA loan at 3.5% down is 580, but one specific mortgage company (or bank) might require you to have at least a 700. Sometimes your Bank or Savings & Loan is better, sometimes a Mortgage Broker is better. Talk to a Professional Member about your situation to see what is available for you.

Automated Underwriting

What is Automated Underwriting (AU)? Most lenders use a computer system to look at your specific application and use its own calculations to determine if it will “Approve” your application or “Refer” it for further review. This is referred to as “Pre-Approval”. A mortgage professional will enter your information into the system and get the results. Many times a mortgage professional can enter several “what if” scenarios with different circumstances to try to get an Approval. For example, what if you put 5% down instead of 3.5%, or if you have 3 months of reserves at closing instead of 2 (we will cover that later) or what if you pay off credit card account? A good mortgage professional will put that time in for you.

What is an Underwriter? An underwriter could be equated to “Quality Control” for a mortgage company. The Underwriter reviews your application, supporting documents, approval stipulations and many other aspects of your transaction to make sure it complies with the requirements of the Approval of your application. Their job is to make sure everything is done right and keep from closing loans that do not meet the requirements of the loan program.

Rate Shopping

What is rate shopping? According to myFico.com, when you apply for certain types of loans including Mortgages, Auto loans and Student loans the “Hard Inquiry” falls into the “Rate Shopping” category. When you apply for a mortgage and a loan officer performs a Hard Inquiry of your credit report it does not lower your credit score for 30 days thereafter. All other things being equal, your credit score will not change until the 31^st day after the first inquiry. This may complicate things just a bit, but there is a “Shopping Period” in which all inquiries will count as only one inquiry. For the FICO® Mortgage Scores that shopping period is 14 days. For example, if you apply for a mortgage on the 1^st day of the month and decide to apply at another mortgage company on the 13th day of the month, the two inquiries will only affect your score as if you only applied once and your score will not be affected until 31 days after the initial application.

Various Mortgage Terms

What is Private Mortgage Insurance (PMI)? A type of insurance that can be required for loans that have less than a 20% down payment. It is based on the amount of the loan and usually between .25% and 1.5% of the balance (based largely on FICO Scores and down payment amount), calculated yearly but paid monthly. For most loans it will no longer be required once the equity in the home reaches 20%.

What is a conventional loan? A loan that “conforms” to the requirements of the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). Normally to use a conventional loan you want to have a higher credit score (over 700) and/or a large down payment. However, some programs offer First Time Home Buyers as little as 3% down with PMI.

What is a VA loan? To promote home ownership among veterans, the Veterans Administration will guarantee mortgages made to qualified veterans that meet certain requirements. These loans typically require credit scores of over 620, do not require a down payment and do not have PMI, but do have an upfront funding fee of 2.15%.

What is an FHA loan? To promote home ownership, the Federal Housing Administration will guarantee mortgages made to people who meet certain requirements. These loans typically require credit scores of over 580, 3.5% down payment and have a 1.75% funding fee and .55% Mortgage Insurance Premium (similar to PMI). You can qualify for an FHA mortgage with credit scores as low as 500 with a 10% down payment.

What is a USDA mortgage? To promote home ownership in the rural community, the United States Department of Agriculture Rural Development will guarantee mortgages made to people who meet certain requirements and are buying homes in rural areas. These loans typically have a minimum credit score requirement of 500, but a minimum of 640 is usually required for automated underwriting. USDA does not have a required down payment but they do have a 1% funding fee and a .35% annual fee (like PMI).

Your monthly payment will consist of Principal, Interest, Taxes and Insurance (PITI).

What is an Annual Percentage Rate (APR)? To be able to compare mortgages with the fees included, a calculation that includes the fees was created to help compare apples to apples when shopping for the best loan terms. APR considers the amount of the fees for your loan and the added PMI/MIP and points.

Debt To Income

There are two different ratios that mortgage professionals look at when determining the maximum your house payment can be. Your “Frontend” or “Housing” ratio is simply your estimated house PITI payment divided by your monthly income. Your “Backend” or “Total” ratio is your total monthly debt including an estimate of your PITI, minimum required payments on all debt listed on your credit report (except term loans with less than 10 months left), and some other things not listed on your credit report such as child support payment obligations.

There is a soft maximum to the DTI you can have on mortgages. It is different in every case, but I use a rough estimate of 31% for your Frontend and 41% for your Backend. In other words, if you have a combined total (both borrowers) of $6,000 per month, your PITI should not be more than $1,860 (31% x $6,000) and your Backend should not be more than $2,460 (41% x $6,000). So you have a margin of about 10% of your total monthly income to spend on a car payment, credit cards, etc. before it starts to reduce the amount of house you can afford based on your Backend ratio. With good credit you can have higher ratios (USDA will allow up to 46% with AU approval and VA could go above 50% in some circumstances).

In this class I strongly advise against buying new cars. One thing I hear often is that if you show you can make the monthly payments on a car, it is more likely that you can get approved for a home loan. That is close to the exact opposite because of the DTI ratio. You only have so much income and you can only spend about 10% of that on monthly debt obligations. Buying an expensive car could easily reduce the amount of money you can borrow on a house to below what houses are selling for and therefore you are not able to buy a home even though you have good credit because of the car payment.

Down Payment & Closing Reserves

Where should you keep your down payment? The best thing to do would be to have a separate savings account that you only make deposits into. Show that you are putting the difference between your current rent payment and your estimated PITI into a savings account. Also, as a homeowner you will be responsible for maintenance issues, so consider putting an extra $100 into that account every month.

The money you use for your down payment must have an approvable and verifiable source. Money in a savings account for more than 60 days meets that requirement. The sale of a previous home or other asset works. Money that you can withdraw from a retirement account or even a “Gift” from a family member or non-profit can work. You need to show the source of that money.

When you close you need to have some money in “Reserves” for the just in case “stuff”. The more money you have in “Reserve” (your bank account for 30 to 60 days) when you close, the less risky your loan is and the more likely it will be approved. Reserves are measured in terms of the number of monthly PITI payments that you have. So, when someone asks how much in Reserve you will have, that’s money still in your account after closing measured in the number of months of PITI payments you have.

Rental History

There are companies that report your rental payments to your credit report, however they do not count for or against your FICO® 2, 4 or 5 scores. Having your rent reported will count as a tradeline and help you get approved for credit when you first start building credit, but it will have a minimal effect on your credit in the long run.

If you don’t have established credit lines, your rent history can be included in the Automated Underwriting system. The system will “automatically identify recurring rent payments in the applicant’s bank statement data to deliver a more inclusive credit assignment.” (fanniemae.com

Please talk to a Wise Credit Professional for advice on your specific situation.

Putting Everything Together

We have covered so much in this class. There is so much to learn and take in that you should be proud of having made it here. Everything we have talked about has led us up to getting you approved for a mortgage.

You understand that, in general, the higher your credit scores are the lower your interest rate will be. You also understand that that the less debt you have the more you can be qualified to spend on a home and/or the lower your housing payment will be. You understand that there are many different types of mortgages available with different qualifications, but the basics remain the same. You understand that buying a new car or applying for new debt in general can hurt your credit and DTI. You understand that you should save the difference between your rent and your estimated PITI in a savings account along with $100 extra for maintenance.

When you are getting ready to apply for a mortgage, please check your own credit scores yourself at myFICO.com. Choose which mortgage professional you apply with carefully because some are openly eager to work with you, however some only focus on more higher-income borrowers. You can always find a Wise Credit Professional to help you.

Remember Luke 16:10 ~ He who is faithful in what is least is also faithful in much… ~

Build your credit using several small accounts. It will take some time, but you reap what you sow. Plant a small seed and let it grow. This completes the “Lessons” or what I would call the “Basics” of Wise Credit Management. For more details on disputing, the Wise Path To Wealth, and other subjects to come, please go through the “Graduation” class on WiseCreditManagement.com and become a Wise Credit Advocate.

Next: Complete the Lesson 10 Quiz (first make sure you completed the Lesson 9 Quiz)