If you are in the market to buy your first home, or perhaps a larger home, before shopping for your next residence, it’s smart to first shop for a mortgage. The reason is you will then know how much cash down payment you need (if any!) and how large a mortgage you can obtain. It’s best to start shopping for mortgage money at least two months, before starting to shop for a home. Why? Because you might have errors on your credit reports and it usually takes at least 30 days to correct them.

I know. Last year I refinanced my home. But before I could get a new mortgage I had to have my credit reports corrected. Bank of America had erroneously reported that one of my monthly payments was more than 30 days late! Just one “black mark” late payment like that on an otherwise flawless credit report can mean either (1) total rejection for a new mortgage or (2) a higher interest rate. Thankfully, I learned about Bank of America’s mistake because I belong to one of the credit reporting services, which alerts me to any negative information, which shows up on my credit report.

After learning of Bank of America’s error, I had to write each of the credit bureaus to dispute the wrong information reported by Bank of America since I made all my payments on time. In the credit world, it’s called “verification.” When a consumer disputes information on a credit report, the credit bureau must either (1) remove the disputed information from the credit report or (2) verify its truth with the creditor if that information is to be left on the credit report. A credit bureau has only 30 days to do this — if the credit bureau fails to verify the disputed information within 30 days, it must be removed.

WHY GETTING PRE-APPROVED FOR A MORTGAGE BEFORE BUYING A HOME IS SO IMPORTANT. The 1999 spring home buying season is proving to be one of the best ever — for home sellers! For homebuyers, it’s very competitive in most cities. Realtors are complaining about a shortage of realistically priced houses and condos listed for sale. As I often say “There’s too much money chasing too few homes.” Although the home sale market isn’t booming in a few cities, most of the nation’s housing markets are doing extremely well. Depending on where you live, in 1998 home prices escalated an average of 5%, but many communities saw market value appreciation of 10% to 20%. Some homebuyers are seeing their first purchase offers accepted by home sellers without much or any negotiation. Why? Because a buyer who can show a pre-approved mortgage letter or certificate from the actual lender (NOT FROM A MORTGAGE BROKER) can then make an all-cash purchase offer which is what most home sellers want to see. However, even mortgage pre-approval is always contingent on a satisfactory appraisal of the home being purchased and, usually, on re-verification of the borrower’s income, credit and employment. After you are pre-approved for a mortgage, don’t do anything, which might change your mortgage qualifications:

EXAMPLE: A few years ago I sold a house on a lease-option to Melvin and Denise. They didn’t have very good credit. But a superb mortgage broker I recommended found them a loan at only about 1% higher than the rate for excellent-quality borrowers. However, before the mortgage was funded, Melvin went out and bought a used car, paying for it with a car loan from his credit union! The mortgage lender rechecked the credit reports a few days before funding the mortgage and discovered the new auto loan. To qualify again for the mortgage, Melvin had to sell the car and get rid of the auto loan.

Homebuyers who do not have a mortgage pre-approval letter or certificate from a lender are at a severe disadvantage. Such “non-approved buyers” should make their purchase offers contingent upon mortgage approval (which can take from a few days to a few weeks). If another purchase offer from a pre-approved buyer comes in, naturally the seller will accept that offer and reject the offer from the buyer who doesn’t yet have a mortgage approved. In today’s ultra-competitive home sales market, home sellers are extremely reluctant to take their homes off the market while a buyer shops for a mortgage (unless there are no other buyers in sight).

DON’T BE FOOLED BY MORTGAGE PRE-OUALIFICATION. Some mortgage lenders — especially mortgage brokers — try to trick borrowers by telling them they are “pre-qualified” for a home loan. MORTGAGE PRE-OUALIFICATION MEANS NOTHING! Pre-qualification means a loan officer merely takes a look at the information you supply, such as gross annual income, down payment, and employment, then telling you “Congratulations. You’re pre-qualified for a home loan.” Being pre-qualified for a mortgage does not obligate a mortgage lender in any way! In essence it means, “If what you told us is true, we think we can get you a mortgage.”

With today’s highly automated, computerized mortgage lending, it is not unusual for a mortgage lender to enter all your personal information, such as income, employment, and down payment, getting a credit rating from all three credit bureaus, and obtaining mortgage approval in less than 15 minutes! However, such quickie loan approvals are subject to verification. Lenders will check your employment, income, down payment and other essentials. Since mortgage pre-app royal is now so quick and easy, there is no reason any homebuyer should rely on meaningless mortgage pre-qualification. Some lenders charge a loan fee for pre-approval (to minimize “loan shopping” among lenders), but other lenders do not charge for pre-approval. Incidentally, after you are pre­-approved for a mortgage, keep shopping for better terms. Just because you are pre-approved with one lender doesn’t mean you are locked-in with that lender and can’t get a better mortgage elsewhere.

WHY GOOD CREDIT IS SO IMPORTANT FOR OBTAINING A HOME MORTGAGE. Gone are the “good old days” when a loan officer took a week or two to gather all your mortgage loan application information, including credit reports, and then personally made a “yes” or no loan approval decision. Today, depending on the complexity of your financial situation, computerized loan approval (subject to verification) takes just minutes after your loan application information is entered into a computer terminal. By the way, the commissioned “loan officer” who takes your loan application usually has no authority to approve or reject your application.

EXAMPLE: Last year when I refinanced my house, a Norwest Mortgage loan agent filled out my loan application and faxed it with copies of my income tax returns to a distant loan processing office in Washington State. The next morning, a loan processor there phoned me with approval of my new loan. Five days later, although I was in no hurry (I think the loan agent was in a hurry to close by the end of the month so she could get her commission), my loan was closed, funded and recorded.

By the way, it’s very smart to close your new or refinanced mortgage on the last business day of the month UNLESS it is on a Monday. Then close and fund your loan on the previous Friday. The reason for closing at the end of the month is you will be charged at the closing for mortgage interest from the day the loan is recorded until the end of the month. You want this daily interest to be as little as possible. Your first mortgage payment won’t be due until the first day of the next following month.

EXAMPLE: Suppose you want to close your mortgage in May 1999. Friday, May 28 is the last business day of the month (Monday, May 31 is Memorial Day Holiday). By closing on May 28, you will only have to pay interest at closing for four days until the end of the month. But your first mortgage payment won’t be due until July 1. The reason is mortgage interest is collected in arrears, not in advance. The payment due July 1 pays interest the lender earned for the month of June. However, if you get one of the rare simple interest home loans where interest is charged daily, rather than being amortized monthly like most mortgages, the date your loan payment is received by the lender (the sooner, the better) affects how much interest you’ll pay. By the way, although your first payment in this example is due on July 1, most lenders give a 10 or 15-day grace period (be sure the lender receives your payment within the grace period, otherwise you’ll have to pay a late fee).

If you close the loan on the last business day of the month, you will only have to pay a few day’s interest. The reason you don’t want to close on a Monday is most lenders will fund such a loan on the previous Friday, thus requiring you to pay interest over the weekend although you don’t yet have the use of the funds until Monday when the loan is recorded. Don’t make a big deal out of this, but you can close on the last business day of the month (except Monday) you can often save a few hundred dollars if you are obtaining a large mortgage.

HOW MORTGAGE LENDERS LOOK AT YOUR CREDIT REPORTS. Credit rating has become very high-tech and sophisticated. Gone are the days of a faceless mortgage underwriter making a very subjective “yes” or “no” decision by considering your income, credit report, down payment, and loan application. Today, in addition to having enough income to afford the monthly mortgage payments, the major factor for approving your home loan is your “FICO score.”

What is a FICO score? Three or four years ago, the two major secondary mortgage market loan buyers, Fannie Mae and Freddie Mac, started automating their loan underwriting. Electronic credit scoring made this possible. Fair, Isaac & Co. (FICO) of Novato, CA created a credit-scoring model, which claims to be able to predict the probability a mortgage borrower will default, based on the borrower’s credit reports.

FICO scores range between 450 and 850 — the higher the better. But Fair, Isaac refuses to divulge exactly what goes into their computerized FICO score calculation which is based only on your credit reports, not your income, employment or other factors. When a lender orders your credit reports, the FICO score will be automatically calculated as part of the credit report.

If your FICO score, based on your credit reports from the three major credit bureaus, is below 620, cautious manual review by a human is required. There could be special circumstances, such as a low mortgage loan-to-value ratio, to get your mortgage approved although you have a low FICO. Or your mortgage might be rated A-, B, C or D and approved at a high interest rate.

If your credit score is between 620 and 659, you might get approved with additional documentation, such as a letter from your landlord stating you pay your rent on time (landlords do not report to the credit bureaus) and proof of on-time utility bill payments.

If your credit score is above 660, your mortgage will probably be approved if you have sufficient income to make the payments. A high FICO score can compensate for negative credit factors, such as a late payment, or lots of unused but available credit. The FICO score unfairly considers unused credit lines as if they are being used. FICO scores seem very arbitrary, but they are a fact of life, which mortgage borrowers must accept if they expect to get a new mortgage.

Unfortunately, prospective borrowers can’t check their own FICO scores before applying for a mortgage. Obtaining copies of your credit reports will not reveal your FICO score. But there is nothing secret about your FICO score, so be sure to ask your lender after you apply for a mortgage what your FICO score is. If it’s low, but your loan is approved, be thankful. If it’s low, but your loan was not approved, ask why and what you can do to improve your FICO score. Although home loans are not approved or rejected on the basis of FICO scores alone, they are a major factor in the lender’s decision, especially if your loan will be sold into the secondary mortgage market to Fannie Mae or Freddie Mac.

If you have a low FICO score, perhaps due to credit circumstances beyond your control such as late-paid medical bills, which weren’t covered by health insurance, be sure to explain this to the lender. Ask if the lender is a portfolio lender. That means the mortgage lender will keep your mortgage in its loan portfolio and won’t sell it in the secondary mortgage market to Fannie Mae, Freddie Mac or another buyer. Portfolio lenders are usually far more flexible than those having to sell all their loans to raise funds. If you have a credit problem, and a low FICO score, a good mortgage broker can direct your loan application to a flexible portfolio lender. Some portfolio lenders charge high interests rates, but others don’t.

WHAT IS IN YOUR CREDIT REPORT? Now that we know why credit reports are so important for obtaining home loans, let’s take a quick look at what is contained in credit reports. In preparation for writing this newsletter, I obtained copies of my credit reports from all three credit bureaus. Surprisingly, they don’t all have the same information about me.

Fortunately, all three credit bureaus showed no collection accounts and no public records reported — public records reported might include a judgment lien, late or unpaid property taxes, and bankruptcy. Several years ago I had a late property tax payment show up on one of my credit reports because an escrow company failed to pay my property taxes on time. The firm had to pay the late fee, but Experian (formerly TRW) reported on my credit report that my property taxes were paid late. Getting that off my credit report took several months of letter writing to Experian. When you find an error on your credit report like that. Write to the credit bureau with the details of why you want the incorrect item removed and insist they send you a copy of the corrected report within 30 days. Be persistent. Don’t give up until you get the desired result.

In addition to any collection accounts and public records, your credit report shows credit lines, credit cards, and other debts (past and present) owed to commercial creditors. If you owe money on a second mortgage to a private party lender, for example, it won’t show up on your credit reports. Neither will utility bills. Surprisingly, some banks and even some major credit card issuers do not report to the credit bureaus. One mortgage lender told me “If it doesn’t show on your credit report, I don’t want to know about it because then I am supposed to verify it and that takes time which will delay your mortgage approval.” “Paid on time,” “paid satis” or “as agreed” are the remarks you want to see on your credit reports. Your credit report also includes any closed accounts, whether you paid them on time or late. However, credit reports do NOT show your income.

Bankruptcies stay on your credit report for 10 years. Other creditor reports about you generally stay on your credit report for 7 years, whether the information is good or bad. Incidentally, Freddie Mac announced that beginning May 1, 1999 it will now approve home loans for borrowers who re-established credit as recently as 24 months after discharge from bankruptcy. Previously, Freddie Mac would not approve a home mortgage until 10 years after bankruptcy and five years after a foreclosure. Fannie Mae, the largest home loan buyer in the secondary mortgage market, has not yet announced any change in its policy regarding bankruptcy and foreclosures.

Inquiries by creditors are also shown on your credit reports. Your FICO score considers too many recent inquires to be detrimental, especially those within the last six months. The FICO people feel that inquires alone, whether or not you get and accept the credit offered, are bad. If you apply for mortgages with different firms, however, FICO is supposed to not count all those inquiries from mortgage lenders. Don’t ask me how they do it! Inquiries must drop off your credit reports after two years (although they should drop off within six months).

BEFORE GETTING PRE-APPROVED FOR A MORTGAGE. GET COPIES OF YOUR CREDIT REPORTS — MAYBE YOUR CREDIT IS BETTER THAN YOU THINK. When I recently obtained my credit reports from all three bureaus, I found significant differences in their reports. That’s why it’s important to check all three credit bureau reports before applying for a home loan. To illustrate, Trans Union says I owe Western Financial Savings Bank $317,250 whereas Experian and Equifax show this mortgage is paid off. That’s quite a difference (by the way, the mortgage is paid in full). I have no idea how that loan showing up on one credit report, but not the others, affects my FICO credit score. Lots of credit lines show up with one credit bureau, but not the others.

If you applied for credit, employment or insurance and were rejected within the last 60 days, you are entitled to a free credit report from the credit bureau, which the creditor used. By all means, get a free credit report whenever you can. Your request doesn’t count as an inquiry. You might be surprised to learn your credit report contains some errors — reportedly over 50% of credit reports are not correct.

The cost of obtaining each credit report varies according to state law. The average is $8 each. Experian (formerly TRW) used to offer a free annual credit report to everyone, but they no longer do so. However, state laws in Colorado, Georgia, Maryland, Massachusetts, and Vermont require one free report each year from each credit bureau. Why doesn’t every state require one free report each year? Probably, heavy lobbying by the credit bureaus. If you are unemployed, on welfare, are told a collection agency has or will report negative information about you to a credit bureau, or feel you have been the victim of credit fraud, you are entitled to a free credit report. When you phone each credit bureau, unless you are entitled to a free report because you were denied credit or are unemployed, etc., or live in one of those five states, you will be told the cost of obtaining your credit report. The latest address, phone and Internet information, as of May 1, 1999, for the three credit bureaus (they keep changing their phone numbers and addresses) for ordering your credit reports are:

TRANS UNION, P0 Box 390, Springfield, PA 19064-0390;
Phone 800-888-4213 or 610-690-4909 www.tuc.com

EXPERIAN (formerly TRW), P0 Box 949, Allen TX 75013;
Phone 800-422-4879 or 888-EXPERIAN www.experian.com

EQUIFAX, PG Box 740241, Atlanta GA 30374;
Phone 800-685-1111 or 770-612-3200 www.equifax.com

As far as I can determine, only Equifax will allow you to order an online copy of your credit report. By the tune you read this report, Trans Union and Experian might also allow online orders. When phoning, use a Touch-Tone phone and have a credit card handy. Before ordering by mail, phone the credit bureau and listen to the recorded instructions. You must send a signed letter with your full name, current address, other address used within the last two years, social security number, date of birth, and the requested payment (unless you are entitled to a free report). At least one credit bureau requests a photocopy of your driver’s license, utility bill or other verification of your current address.

When you receive your credit report(s), READ IT! The credit bureau should include a dispute form to return if you disagree with reported information. Challenge anything you believe is not correct. If you are not treated fairly by the credit bureau, you can write to the Federal Trade Commission, Correspondence Dept., Room 692, Washington, DC 20580. But don’t expect much — it’s a government agency and my experience with the FTC is it is toothless! Their website is www.ftc.gov.

Although I have not personally used this service, for $30.95 CREDCO will send you a combined “Confidential Credit” report from all three credit bureaus. Phone 800-443-9342 for an order form to be filled out and returned with your payment. With a credit card, you can fax the form back to CREDCO. Incidentally, this is the firm, which Norwest Mortgage used to check my credit.

WHAT SHOULD BE DONE IF YOU HAVE BAD (OR NO) CREDIT? Ifyou read the classified newspaper ads in most major cities, you will see firms, which advertise — for a hefty fee — they can clean up your credit. Most of those firms are scams. Save your money. If your credit reports are bad, dispute any incorrect information. But if you messed up and paid creditors more than 30 or 60 days late without a valid reason, have judgments or a bankruptcy, you still have many home mortgage alternatives. Our Report #98288 “How to Buy a Home If You Have Bad (or No) Credit” shows how.

Lots of mortgage lenders will still loan to you if you have bad credit. But at a higher than normal interest rate. That choice might be better than not buying your own home. To illustrate, a few years ago I sold a house to a nurse who had great income, but horrible credit. My real estate broker, the great Mark Benson, shopped for weeks to get her a mortgage. Finally, Beneficial Finance granted her a mortgage at 11.5%! She paid it on time for two years. Then she refinanced at what, I presume, was a “normal” interest rate. But I was disappointed, because when she refinanced her first mortgage, she paid off my second mortgage, which was producing great income!

Mortgage lending to “sub-par” borrowers has become big and very profitable business. Just because you’re not perfect doesn’t mean you can’t get a home mortgage. Most of the major non-bank lenders, such as Countrywide, now have affiliates, which originate home loans for sub-par borrowers with A-, B, C, and D quality credit. A good mortgage broker can arrange such a loan, or you can go direct. Check out the many online lenders, such as www.countrywide.com. I’m not recommending that lender (I had trouble filling out their online application form!) but their website is a good place to start.

HOW TO BUILD OR REBUILD YOUR CREDIT. Ifyou have NO credit, probably because you pay cash for everything or buy money orders at the post office, you can still buy a home and get a mortgage. Work with an experienced mortgage broker who is willing to verify your financial obligations, such as rent payments, utility payments, and other debts you pay on time. To illustrate, last year I received a phone call from a mortgage broker about a tenant who moved out of one of my rental houses several years ago. Since my ex-tenant paid rent on time (always in cash), I was glad to fax back a statement that my former tenant always paid his rent on time. This is the type of information lenders are willing to accept when a mortgage applicant has NO established credit

It is much easier to lose your good credit, than to rebuild it. Unless you have no other alternative, DON’ T file Chapter 7 bankruptcy. It will ruin your credit. A better alternative is to file Chapter 13 bankruptcy reorganization (Chapter 11 for business bankruptcy reorganization) and pay your repayment plan payments on time. To illustrate, my former tenants and homebuyers Paul and Karen did that. I helped them buy a house from me by taking over “subject to” payments on the existing bank mortgage. They profitably sold their house two years later and moved to Maryland. I received a phone call from their prospective Maryland mortgage lender there. Paul successfully completed his Chapter 11 bankruptcy reorganization plan, paying all his creditors as agreed, and they got their new mortgage to buy a home in Maryland.

If you have no credit and want to start establishing credit, start with the easy creditors such as department stores and gasoline companies. Your bank should also grant you a Visa or MasterCard without delay. Pay on time every month to establish your credit. After six to 12 months of on-time payments, you will have an established credit report. You will probably begin receiving pre-approved no-fee credit card applications. Take them. But pay them in full every month to further establish your good credit.

THE TOP 10 REASONS MORTGAGE APPLICANTS GET TURNED DOWN: Just one negative item on your credit report, if it is severe, can result in rejection of a mortgage application. Primary reasons applicants are rejected for mortgages include (1) no credit file (usually because the applicant pays cash and has not established credit), (2) insufficient information in the applicant’s credit file, (3) insufficient income, (4) short time on the job — at least two years in the same field are usually required, (5) slow pay and/or poor credit history, (6) judgments, garnishments or bankruptcy, (7) accounts sent to collection agencies, (8) bankruptcy, (9) foreclosure, and (10) repossession (such as an automobile). As explained earlier, no credit or insufficient credit can often be overcome so you can obtain a mortgage. But the other reasons are more difficult.

DON’T CO-SIGN OR GUARANTEE ANOTHER PERSON’S LOAN.If you are asked to co-sign or guarantee another person’s loan, watch out. All the credit co-signed or guaranteed will appear on your credit report. If the primary obligor fails to pay, you will be expected by the creditor to make the payments. Even if you pay, but the payment is late, it will show up adversely on your credit report.

No matter how much you love the person who requests your help, think extremely carefully before you co-sign or guarantee a debt. Realize that if that person doesn’t pay, you will be expected to pay to preserve your good credit. Perhaps you want to help a son or daughter, fresh out of college, buy their first home. That’s great. But if he or she can’t qualify on their own, maybe the lender is telling you this is a very high-risk mortgage.

FURTHER DETAILS.Building or repairing your credit is a never-ending job. Nobody has perfect credit. It’s often too much or too little. Personally, several lenders have told me I have too much credit. Yet, they keep giving me more! I love those unsolicited, “Congratulations! You’re pre-approved for our credit card” letters.  Additional information is available in two excellent books, both available at local bookstores, public libraries, and www.realestatebookstore.com.  “All About Mortgages”, Second Edition,by Julie Garton-Good (Dearborn-Kaplan Publishing Co., Chicago, 1999) and “The Credit Repair Kit”, Third Edition, by John Ventura (Dearborn Financial Publishing Co., Chicago, 1998).

 

COPYRIGHT 2004 BY ROBERT J. BRUSS

This publication is intended to provide scant and authoritative information. It is sold with the understanding the publisher is not engaged in rendering legal services to readers. If legal or other expert assistance is required, services of a real estate attorney or other professional should be obtained.