As a loan officer, I talk to people day in and day out and no matter how diverse my clients are I always end up asking the same question: What’s your credit like? The more savvy clients i.e. the ones who have bought or refinanced a home before, know exactly how good their credit is and know that every loan officer they talk to is salivating over the chance to do a loan for someone with a 720+ credit score. For everybody else, that question prompts me to deliver my mini-speech on credit. I don’t mind—I enjoy educating people and hope that I am the one loan officer they talk to who is willing to take the time to explain the complicated nuances of credit. With that in mind, I set out to create an article setting out those basic lessons for people who are buying their first home or those who are doing a refinance for the first time. In my opinion, there are three important things a consumer can do before applying for a loan, in order to get their finances up to speed. It can take up to six months for your credit report to be updated by the credit reporting companies, so start now and you’ll be ready for the future.
1. Check your credit report. Under the Fair and Accurate Credit Transactions Act, consumers can request and obtain a free credit report once every 12 months from each of the three nationwide consumer credit reporting companies (Equifax, Experian, and TransUnion). You can go to https://www.annualcreditreport.com/cra/index.jsp to request a free copy of your credit report. This is the only site authorized by the three major credit bureaus for the purpose of obtaining a free copy of your credit report. You can request the reports via e-mail, telephone, or mail. While the report you receive from the site will not provide you with a credit score, it will give you a complete copy of your credit history—that’s all you need for now. Take some time to review each entry. This is also a good time to make sure you are not a victim of identity theft. Do you have any late payments or delinquencies? Are there any errors? Is there any unfavorable public record information? Are there collections disputes? Decide whether to resolve or dispute every negative item on your credit report. Even small items such as a past due account with a utility company can show up and adversely affect your credit so take care of it now.
2. If you carry a balance on your credit cards, start paying them off. We all know that we’re supposed to do this but many Americans keep putting it off. Here’s the deal: when you apply for a home loan, the loan underwriter will look at your ability to repay your total debt and a large annual salary usually does look pretty good. However, the underwriter will also look at the current debt that you carry on revolving accounts and how much you pay for that each month. Oftentimes, they will even calculate it at 3% of the balance rather than your monthly minimum, which really makes a difference when calculating the ratio of your monthly obligations to your salary. For those of you who are paid well, don’t fall into the trap of thinking that a hefty salary is enough. I recently had a client who made over $70,000 per year. He resisted paying down the balances on his credit cards because he thought his salary was enough to qualify him for a good rate on his loan. He was wrong and we had to put him into an alternative documentation program with a less than favorable interest rate. In short, start making a serious effort to pay off your credit cards.
3. Start saving to pay for closing costs. Closing costs are the costs associated with the closing of the loan e.g. title costs, loan fees, discount fees, inspection fees, appraisals, etc. If you are refinancing your current home, you can finance the cost of closing into the loan amount. However, when you purchase a home, you will be expected to bring these fees, which can range from $3000 to $7000, into closing with you. There are loan programs that allow you to finance the closing costs of your loan, but be prepared to pay a premium for that convenience. If you’re relying on the seller to pay closing costs, keep in mind that what the seller pays in closing costs is considered to be a rebate on the price of the house. If the house doesn’t appraise within the range, the seller can’t pay your closing costs. For instance, say you find a $200,000 home and the seller is paying $5000 in closing costs. What the seller is actually getting for the house is $195,000 i.e. the $200,000 sales price less the $5000 the seller gave back to you in the way of closing costs. An appraisal is a written estimate of a property’s current market value based on recent sales information for similar properties, the condition of the property, and the neighborhood’s impact on future property value. A lender will lend a dollar amount based on the appraisal. Therefore, if this hypothetical house appraises at $200,000, all is good. BUT if the house appraises at only $195,000, then you can count on only getting a loan for up to $195,000 so you’ll have to bring the $5000 difference between the $200,000 asking price and the $195,000 appraisal price in with you anyway. In that case, why have the seller pay closing costs at all? In short, one way or another, you will pay for closing costs, so just start saving for it now.
While these steps are not exclusive, they will put you on the right track to qualifying for the best mortgage possible. The months before buying your first house are an important time to be frugal and avoid any negative impacts on your credit report.
About the Author: Cassandra Forbess is a loan officer who specializes in mortgage planning at Mt. Financial Services in Portland, Oregon.