Basic Credit Considerations From The Lender´s Perspective
A Conversation With Victor Andrade From Meadowbrook Financial Mortgage Bankers
VAndrade@mfmbankers.com Cell: 347-495-2506
Victor specializes in residential financing for over 17 years, and he is going to tell us what the credit considerations for home financing should be. Credit is a key part of a transaction, the others being the borrower´s income, the assets or down payment, and the property which serves as collateral for the mortgage. With credit, they make the 4 legs of this hypothetical table that is a real estate financing transaction. With weak credit the table is wobbly and won´t pass the lender´s test. So, Victor will tell us how to set up credit, increase your credit rating and avoid common pitfalls while managing your credit.
Here is my first question Victor. Since we have a lot of first-time home buyers and buyers who are immigrants and who may manage finances in a different way, can you explain how do you establish credit when you have no credit history?
The easiest way is to have someone who has good credit add you onto a couple of their credit cards as an authorized user. As time passes and these accounts are being paid on time by the original credit card holder, your credit will start being reported and your score will improve. This is the way my mother set up my credit when I was young. I was careful enough to use these credit cards responsibly so as not to damage her credit, while I started my credit history, or else my mum would have put a hurting on me…
You want to look for a relative with good credit, typically that person that is fastidious and organized with their finances, not that deadbeat relative that is maxed out on credit cards.
When I started, 26 years ago, there used to be this other avenue to start your credit history, where your car insurance, your mobile phone bill or your utilities would count towards your credit. Does this still work?
Yes, nowadays the credit bureaus, Transunion, Experian, Equifax, they allow for you to add your utility bills, cable, insurance, etc. to your credit report. You open an account with one or three of the credit bureaus and you just add these accounts as a self-reporting utility bill on your credit report. I can assist anyone who needs help doing this and it is a rather simple process. Just make an appointment with myself or call me and it will just take minutes.
My next question is what is the lender looking for when they investigate a borrower´s credit? Are they checking the borrower’s ability to manage credit or are they checking for debt-to-income ratios? Please explain.
What they are checking for is basically your ability to receive a bill and pay it as agreed or better than agreed. That you are responsible and organized, that you can manage a checkbook, that you can manage a credit line responsibly. In other words, that you don´t get in over your head or that you are not sloppy with your existing credit lines.
As to the general idea, since we want to stay basic here, about the DTI or debt to income ratio, this is the ratio of the debt that you owe (or will owe) over your income. Lenders will divide debt by income and come up with a ratio, and they will have certain standards which vary by mortgage program and which you will have to meet in order to qualify for a mortgage. DTI can also be explained as the percentage of your income that will be dedicated to pay your mortgage obligation and your outstanding debts. For example, if you make $120,000 a year, that equals $10,000 per month; If your mortgage payment is $3,000 and then you have a car payment and credit cards in the amount of $1,000 more per month, then your total debt payments are $4,000 which are 40% (4,000/10,000) of your monthly income, making your DTI 40. So basically, the DTI allows the lender to compare your debt against your income and allows us to determine how much you can borrow for a mortgage or how much is too much.
I know there are many different mortgage lending programs, but can you tell us what are the minimum credit scores required by the most common mortgage programs?
The most common programs are Conventional and FHA financing. Conventional are backed by Freddie Mac and Fannie Mae. If you are self employed and are providing one year of tax returns you typically need an average credit score of 700; If you show two years of tax returns (as self-employed or w2 wage earner) you can go as low as 640 in your average credit score. For the FHA loan, most banks would go as low as 640; our company would go as low as 620 depending on the DTI ratio, and in some instances, we can go as low as 580 credit score if the DTI is below 43%. This is very contingent on compensating factors, like your income and assets. These criteria have been steady in the last 10 years, but you seldom hear about these lower scores requirement because very few people meet the compensating factors. For example, I was working with a lady that just had come out of a divorce, which had damaged her credit. Now she was paying on time and her score was improving slowly. We did look at her credit before the divorce and it was acceptable and she now had good income and assets, so we were able to approve her despite her relatively low score. So basically, these lower credit scores are exemptions that could be done on a case-by-case basis.
In my real estate agent´s mind I thought very good credit was 750 or so and when I saw credit in the 800´s I would think to myself, wow, you must be thrifty because only thrifty people have such good credit… lol… So, my question is what credit score allows you to get a better rate in your mortgage? Cold you get 1/8 of a percentage off because your credit is excellent?
The interest is not only based on the credit score. It is true that the higher the credit, the better that the mortgage interest rate could be, potentially. But there are many other factors influencing the mortgage rate. If you have a score of 700 and you are buying a 1 family house (this plays a role too) and you put down 40%, you could get a better rate than someone with a 780-credit score putting down only 5% for down payment or buying a 2-family house. Credit scores are understood in “buckets” or groups, so anything above 740, would get treated the same way. The next bracket below is 720 to 739, the next one is 700 to 719, 680 to 699, 660-679 every 20 points. And with the lower the credit, the more compensating factors are needed to qualify. So, credit score alone is not the only factor that determines your rate.
If you have credit issues, at any level, how do you improve your credit and how long does it take?
This is a very open-ended question. The first thing I would do is to address collections. Collections in your credit are telling a lender that you are financially drowning. So, you want to start paying off the collections and don´t be alarmed if you credit goes down initially to then start recuperating slowly. The reason is that when you pay off your collection, you are acknowledging that it was yours, so your credit goes a tad lower before it starts going up. This is why collections are so damaging. But now you are no longer drowning.
If you have lateness in your credit, the remedy is time, to pay on time. Then your score would start improving over time (this depends on each case). Here it is important to note that your high balances, or how much you owe as compared to the entire credit limit, also makes a difference. If you are too close to the limit, or above, your credit won´t improve. Ideally you want to keep your credit card balances at 25% of the allowed total, for your credit to improve. If you credit limit is $10,000 in your credit cards and you owe $9,999 that means you are choking in debt and your credit score will be lower so you cannot take additional debt. So, you can use your credit, but you should keep the balances low, or try and pay the amounts you use at the end of every month.
Another way to improve your credit score is what we said at the beginning. Have another person add you as an authorized user in one or two of their accounts if they in fact have good histories. Like in the case of new credit, your score should also improve this way. Now this doesn´t mean that you don´t need to address the derogatory information in your credit report, because that does still need to be addressed.
One of the misconceptions about credit that some people have is that to improve their credit scores they need to pay off all their credit cards and close the accounts. Explain to us why this is a big No no.
Well, you are basically telling the lenders out there, I can´t manage my credit, so I had to close all of it. Terrible. You don´t want to do that. How are you going to show the credit bureaus that you can manage your credit if you have no accounts? So, what you want to do is to pay the credit cards down to a small balance, or to zero, but do not close them, leave them open. And use them and pay them off every month. Then the credit bureaus will see that you can manage your credit, that you are not choking, and your score will go up.
If somebody who has credit issues is thinking of buying a house, could they resolve some or most of these issues in the 60-90 days that a typical transaction takes?
Yes, they could. But depends on the issues. I must look at every case to be able to determine how long a credit repair will take. We need to be very careful, because we need to be transparent to all parties in the transaction and not risk the buyer´s deposit in any ways. You know, the buyer is representing in most standard contracts that they have the necessary credit to obtain financing. If they don´t, then they are making a misrepresentation and their deposit could be in danger. So, we must look at the credit issues in every specific case to be able to tell how long they will need to be remedied and then talk to everyone and see if the time frame can be worked out to everyone´s satisfaction. And a lot of this can be stressful, so my advice is to do what we are doing now, educate yourself before you even start shopping for a home, set up a consultation with a mortgage professional to look at your credit and the potential issues in advance.
Very well. Let´s say someone has good credit, good income, good down payment, no issues. What are the to do´s and not to do´s while they are in contract to purchase a home as far as credit?
Don´t do anything. Just kidding. Obviously, you want to keep paying your bills on time. You don´t want to get more credit lines and you don´t want to increase your balances. So, don´t run out after signing the contract and buy new furniture on credit or get a new car with a loan. All of these could lower your credit and/or affect your DTI ratio creating potential trouble to get a final mortgage approval. Don´t let your credit be run after you are in contract. This is going to produce questions from your lender. Basically, wait until you close on the property to do any of these things.
Sometimes people mismanaged their credit, and they look for help. How reputable are these credit consolidation, credit repair or credit negotiating companies? Can they be trusted?
You really must be careful because there are a lot of scams out there. I have seen where people get charged to repair their credit and then the work is not done. Or they are given the wrong advice. Be careful. There are some outfits that are reputable, but you also must understand that nothing is guaranteed, everything is very case by case, this is not an exact science. Some companies overpromise or flat out lie. So, I don´t like to refer people to these credit repair companies.
Instead, when I look at a client´s credit report and I see the issues, I can advise them, without charge, given them direction and tips, to improve their credit to prepare them to buy a property, maybe if it is not now, in six months or a year. My offices are in Astoria, Queens, and my cell phone number is Cell: 347-495-2506. We can set up a consultation, without any obligation or charge.
Thanks for that. I know you are very reachable and that you provide the service that some of the big banks will not. A couple of final questions. What about a cosigner or cosigning for someone?
Cosigners will help you qualify with their income. Here is the important thing to keep in mind. If you get a cosigner, and you pay the mortgage on your own for at least 12 months, then that cosigner can go and purchase their own home without your mortgage affecting them (apply this to yourself if you are the cosigner).
Our final question is about another misconception people have. Does your credit score go lower when you get preapproved for a mortgage?
The credit scores go lower when you check it for car loans, credit cards and things of that nature. Since Frank-Dodd regulations came up in the early 2010´s you getting preapproved for a mortgage does not affect your credit score. That way you can shop around for a mortgage and find the best rate. If someone is telling you not to check, is probably a lender that does not want you to get another estimate because they don´t want to lose the business.
Thanks a lot for all the information. By the way, Victor speaks Spanish as well. He is an expert on his field and has a great reputation.
Thanks for having me.