In recent years, mortgage underwriting requirements have become stricter, and the days of closing real estate deals with high leverage, low to no down payment, minimal documentation, and easy approvals are over. Faced by new regulatory requirements and an overall aversion to risk, many financial institutions have pulled in the lending reins by tightening credit standards, often requiring in-depth proof of income and assets, better credit scores, and higher down payment amounts (up front equity invested in the property) than before the financial crisis.
The good news is that lenders are looking for qualified borrowers, and there are signs that frozen credit markets are beginning to thaw. A recent Federal Reserve survey found that 6.1% of respondents said their bank’s credit standards had “eased somewhat” or “eased considerably.”1 Understanding the best way to navigate the mortgage process’ “new normal” can help increase your chances of getting the loan you need at the best possible rate.
Check your credit. Your credit history and scores are important factors on which your lender will base its approval of your loan as well as your interest rate. Credit scores, including the sector-leading FICO score, are based on a number of factors including the length of your credit history, payment record, total credit, and the number of recent inquiries for credit. The February 2013 Ellie Mae Origination Insight Report, which includes data on mortgage trends, found that the average FICO score of loans closed in February 2013 was 745.2 However, it’s possible for borrowers with lower credit scores to be approved, depending on assets (also referred to and viewed as “reserves”), debt ratio (used to measure “capacity” to repay), and on the loan-to-value ratio of the home and among other factors.
The federal Fair Credit Reporting Act (FCRA) entitles U.S. citizens to receive one free credit report per year via www.annualcreditreport.com or by calling 877 322-8228. This report will not include your credit score, but will include information about how to purchase your credit score from one of the top three reporting agencies — Equifax, Experian or Trans Union. It’s a good idea to get copies of your report and score from all three bureaus and check for errors or expired information. A recent Federal Trade Commission study found that one in four consumers had errors on their credit reports.3 Negative misinformation can drive down your credit score, which may affect your interest rate or cause you to be denied for the loan altogether.
Reduce your debt. In addition to credit scores, borrowers look at the amount of debt you carry, including credit card, automobile loan, student loan, and other outstanding balances. High debt-to-income ratios can reduce the mortgage amount for which you qualify or could cause your application to be denied. As a general rule, your monthly housing cost, which includes your mortgage principal and interest, property taxes, hazard insurance premiums, and private mortgage insurance premiums (if applicable), should not exceed 28% of your gross monthly income. Add in total monthly payments on items such as car loans, credit cards and other debts and the total typically shouldn’t be more than 35% of your gross monthly income. Although these are general guidelines to consider, higher ratios may be available, but at potentially less favorable terms for interest rates and fees.
Meet with a loan officer or advisor. It’s never too early in the process to meet with an experienced, reputable loan advisor to help you evaluate your situation. Your advisor can inform you of the various loan programs and products available, including conventional mortgages, government-backed mortgages, jumbo mortgages, and other lending products. Interest rates, down-payment requirements and other loan terms may vary significantly from program to program. For example, a Federal Housing Administration (FHA)-backed loan may require as little as 3.5% of the purchase price as a down payment while a conventional mortgage might require 20% or more. If your credit score and debt ratios are within the bank’s target ranges, your advisor might be able to give you same-day conditional loan approval.
Prepare your paperwork. A conditional approval is just that — a preliminary green light that will be honored as long as other conditions are met. The next phase of the process begins. You’ll be asked to fill out a complete application and provide documentation of income, assets, and expenses, including pay stubs, bank statements, and two years of tax returns. The lender will likely require you to fill out Internal Revenue Service (IRS) Form 4506-T , which allows the lender to receive a transcript of your tax return from the IRS. Be sure to keep copies of all paperwork just in case the lender needs anything resubmitted.
Understand interest rates. Your loan representative will explain the interest rates for which you qualify. Fixed interest rate loans “lock in” at a specific rate, so they won’t change as long as the loan closes as planned. Adjustable-rate mortgages (ARMs) may change from year to year, although they may have a fixed-rate period for a period of time, such as three or five years, at the start of the loan. While the interest rate the bank offers you may be slightly more than advertised rates depending on your credit score, debt, and loan-to-value ratio, beware of lenders who offer very low introductory rates and then try to sell you a loan at a much higher rate. Even a few tenths of a percentage point difference can mean many thousands of dollars over the life of a 30-year loan. In some cases, it might make sense to pre-pay some of the interest — often called “paying points” — to reduce your monthly payments. TIAA-CREF, through its banking subsidiary TIAA Direct, has some useful calculators that can help you compare current loan products and understand the interest you might pay over time.
Familiarize yourself with fees. By law, your loan representative must provide you with a good-faith estimate that summarizes any fees and costs associated with your loan, as well as the terms and interest rate. Review the fees and don’t be afraid to question them. The Federal Reserve published an excellent overview of fees that might be expected, as well as typical ranges.
Know what you can afford. Remember that every home comes with hidden costs. In addition to the down payment, closing costs, principal, interest, hazard insurance, and property taxes, you may have homeowner’s association fees, utilities, private mortgage insurance (for loans that exceed 80% of the home’s value), and improvements or unexpected repairs. It’s important to not underestimate the total expense of purchasing and running your home, or you could soon find yourself racking up debt.
Be patient. While your conditional approval may be done in a flash, today’s loan underwriting process can take as long as 60 days or more, depending on the circumstances. You may be asked to provide additional documentation or resubmit paperwork. Keep in touch with your loan advisor, who should be able to answer any questions you have about the process. On the closing date, when the loan agreement is signed, be sure to double-check the paperwork, fee schedule, interest rate, principal and other terms to be sure there are no errors.
If your loan or refinance is denied, don’t be discouraged. Often, your loan advisor can tell you specifically why and help you develop a plan to address the issues. Perhaps you need to pay down additional debt or save more of a down payment. Create a plan to address the issues and, when you’ve done so, apply again.
1 January 2013 Senior Loan Officer Opinion Survey on Bank Lending Practices, Board of Governors of the Federal Reserve System, Released February 4, 2013. Question 13. http://www.federalreserve.gov/boarddocs/snloansurvey/201302/fullreport.pdf
2 February 2013 Ellie Mae Origination Insight Report, Ellie Mae. http://elliemae.uberflip.com/i/116334/0
3 Federal Trade Commission News Release, February 11, 2013. http://www.ftc.gov/opa/2013/02/creditreport.shtm
The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons.
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