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Why Should You Check Your Credit Report?

Credit and Mortgage Loans

Most people have heard that it’s a great idea to check their credit reports before applying for a mortgage loan.  Many, however, do not really know why.

I mean, they know there could be errors in their reports and some errors bring down their scores.  But they do not know the rest of it.

Your credit report has two components: scores and history.  Each one can kill a mortgage loan application.  But things are not as simple as that.

Credit and Mortgage Loans

Scores

Credit scores determine if you get a loan at all.  Together with LTV’s (loan-to-value ratios) they determine how much you are going to pay for your loans, that is to say, they determine the interest rate and, often, the amount of reserves you need.

Treshholds

There are lenders that lend to anyone with a middle score of 500 (assuming they meet all the other requirements).  Some want at least 580, others 600 or 620 or 640.  The lower the middle score, the fewer options and the higher the interest rate, though.

Also, if the middle score is under 640 (for some, under 620), the application goes to manual underwriting.  Manually underwritten loans, for most lenders, limit the amount someone can borrow.  More precisely, they insist that DTI (debt-to-income ratio) be smaller.

Conventional conforming loans (loans that Fannie Mae would buy) allow for DTI’s as high as 50%.  FHA allows the housing DTI to be 47% and total DTI to be 56%.  However, if the middle score is so low that manual underwriting kicks in, the DTI is going to be 37% for the housing debt (principal, interest, mortgage insurance premium, hazards insurance premium, property taxes, home owner’s association fees, if applicable) and 43% for all debt.

Example:

Income: $4,000/month

Other Debt: $300/month

Property Taxes: $400/month

Property Insurance: $100/month

No HOA

Interest Rate: 3.750%

Loan Type: 30-Year, Fixed, FHA

Income: $4,000/month

Other Debt: $300/month

Property Taxes: $400/month

Property Insurance: $100/month

No HOA

Interest Rate: 3.750%

Loan Type: 30-Year, Fixed, FHA

Manual Underwriting Automatic Underwriting
The loan amount can be just a bit higher than $253,800 The loan amount can be only a bit higher than $180,455.
Manual Underwriting Automatic Underwriting
The mortgage debt (principal, interest, mortgage insurance, property insurance, property taxes) is $1875.70. The mortgage debt (principal, interest, mortgage insurance, property insurance, property taxes) is $1478.16.

The above calculation assume that the FHA’s upfront insurance premium of 1.75% of the loan amount is included into the loan. In my part of the world, $50,000 extra buys a lot.

History

History means significant credit events (bankruptcies, foreclosures, etc.), it also means patterns and recent lates.  Some lenders just don’t have programs for people who have a bankruptcy (foreclosure, etc.) on their credit reports.  Some have programs for people who had one of those events yesterday (i.e., it was recorded as closed yesterday).

Some lenders want no lates on a mortgage in the past 12 months; some can deal with 1, some with 2.

No lender I’ve come across will deal with accounts that are in dispute.

Some people, even if they have credit scores that are high, cannot qualify for a loan because of the credit history; some can qualify but at interest rates that are too high for their tastes.

Because negative histories mean higher risk to lenders and higher risk means higher interest rates.

Conclusion

Yes, it pays to check your credit report long before you apply for a mortgage loans.  Because you might need to increase your credit scores.  Because you will find out if you can only qualify for a loan with high interest rate if you don’t wait and/or fix your report.

Time and not being late fixes everything, but it can take a lot of time.  Often, a more proactive approach is needed.  Sometimes, as proactive as hiring a credit repair company, sometimes only as proactive as challenging one item in the report.