When Tom and Becky started their home search they checked their credit scores first. Tom’s was a respectable 730 and Becky’s was 710. They did their homework too, shopping around for the best interest rate and getting prequalified for a loan before they started going to open houses. A short time later they found the perfect home at the right price.
On the night of their scheduled closing they were ready to sign when their closing officer’s cell phone rang. He handed Tom the phone. Their rate was much higher than Tom expected and the loan couldn’t be approved after all.
It’s a scenario many potential homebuyers fear. And while it is rare, it does happen. It happens when prospective homebuyers go on credit card binges, buying big ticket items for their new home like furniture, paint and appliances once their loans are approved.
With today’s economic uncertainty, there are nervous underwriting departments with stricter processes than before. Because of the bad loans that were approved during the less stringent subprime market of the late 1990s and early 2000s, some underwriting departments are taking a last minute look at credit scores to insure the prospective homebuyer won’t be overextended when the first payment is due.
In fact, because of lender caution, the minimum requirement for the best rates on a 30-year fixed mortgage is 20 points higher than it was just a few years ago. But your credit score is only one major part of the picture. Another factor is loan-to-value. The loan-to-value is a way to tell how much of a property is being financed. For example, in round numbers, let’s assume you want to buy a home that’s appraised at $100,000. You pay $20,000 for a down payment and finance the remaining $80,000, making your loan 80% of the home’s total value. So your loan-to-value is 80%. This is a much less risky scenario than loans that are for 100% or more of the home’s value.
But if your loan-to-value is 100% of the property’s value, all is not lost and there are strategies potential homebuyers can use. Many real estate agents who feel a responsibility to their clients are telling them to keep good credit data, to not go crazy buying things before the closing and to wait until they are in their new house or condo a while to see how they use the space because they’ll be better able to assess exactly what appliances and furniture they need. Vigilant consumers have the advantage. Potential homebuyers who pay their credit card bills on time and monitor their balances going forward are being rewarded with more attractive mortgage rates. Consumers who are late once on a credit card bill, but have a history of being clean over the last couple of years, are also granted certain leniencies. Bringing balances on all lines of credit, especially credit cards, to 50 percent of their limit while cutting from there is the key.
The bottom line for new homebuyers is to not go wild buying things right before their closing. When working with a lender it’s important that homebuyers have realistic expectations about the mortgage rate they can secure. Good mortgage lenders explain the process with you every step of the way. The better your credit score and loan-to-value percentage, the more attractive your mortgage rate will be. By thinking long term about how you’re going to afford everything once you get into your new home, you won’t be distracted by as many short term purchases.