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August 27, 2007

How Your Credit is Evaluated When Approving Your Loan

How Your Credit is Evaluated
When Approving Your Loan

by Michael Licamele

Credit standards have been standardized over the past several years, as the large institutions such as Fannie Mae and Freddie Mac have established guidelines for credit. Since most mortgages are sold to these institutions, their standards are in effect at most institutions. If your credit history does not meet these standards, you may be able to obtain what is called a non-conforming B-C-D credit loan at higher rates.

The following guidelines are in effect at Fannie Mae, which is the ultimate purchaser of most conventional mortgages. These guidelines should give a feel for how underwriters evaluate the credit portion of an application. If you are not sure whether you meet these guidelines, you should obtain a copy of your credit report from the three major credit reporting companies.

 
FNMA Guidelines:

The borrower's credit history should demonstrate his or he past willingness and ability to meet credit obligations that will who the borrower's commitment to making payments on the new mortgage being considered. They are more concerned about a borrower's overall pattern of making payments than they are about a few individual occurrences. A borrower who has made payments on outstanding or previous credit obligations according to the contractual terms will have a credit history that consists of no late payments and no adverse or derogatory information (such as bankruptcies, judgments or collections).

In some instances, a borrower’s credit history may reflect an occasional late payment that is not necessarily attributable to the borrower's disregard for his or her credit obligations. Outside factors-such as slow mail, disputes, different creditor reporting or rating methods, etc.-may have resulted in the reporting of the late payment(s). To make sure that a borrower who has an otherwise good payment history is not penalized for an occasional late payment, we do not require perfect or spotless credit records. The lender must evaluate the age of any account that reflects late payments, the frequency and severity of the late payments, the size of the account balance, how long ago the late payments(s) occurred, and the status of the borrower's other credit accounts.

The lender will look at the borrower's credit history over the past seven years to determine whether there are any major indications of derogatory credit (such as undisclosed debt, judgments, bankruptcies, etc.). However, the lender generally reviews only the past 24 months for minor instances of derogatory credit to ascertain that the borrower has a sufficient number of accounts without adverse ratings to support a determination that his or her overall credit history is an acceptable one. Unless the borrower's credit history over the last 24 months raises some serious concerns (or there are major indications of derogatory credit at any time during the last seven years), the lender will consider a borrower's credit history as acceptable if, over the last 12 months the borrower has had no more than 2 revolving and 1 installment loans past due.

If the credit history reflects a consistent pattern of slow payments, undisclosed debts, suits, judgments for non-payment of obligations, bankruptcies, etc, the lender must investigate each major indication of derogatory credit. In most cases, a letter from the borrower may provide a sufficient explanation for the derogatory credit; in others, additional supporting documentation may be required to back up the borrower's explanation.

If a major indication of derogatory credit cannot be explained and there are no extenuating circumstances to be considered, there must be strong offsetting factors in order for the borrower to receive favorable consideration. If a borrower has no credit, underwriters can develop a credit history for borrowers who normally do not use credit or do not have the type of credit history that will not appear on a credit report. Credit histories can be developed from rent payments and utility bills such as electric, gas, telephone and cable.

Finally, a borrower will generally be denied for a mortgage loan if the borrower has been a defendant in mortgage foreclosure proceedings in the last three years. If a borrower has experienced a foreclosure or bankruptcy in the past three years, it is crucial that the borrower reestablish a good credit history during that time period. A borrower can use secured credit cards, a loan with a co-signer, a credit union loan, or local store cards.

 
NON-CONFORMING LOANS

If your credit history is not acceptable under the description above, you have two choices. The first is to work on creating a positive credit history over the next one to two years by cleaning up old debts and making all current debt payments on time. The second option is to make a larger down payment (usually 10% to 30% down) and obtain a loan with a higher interest rate.

These programs carry interest rates that range from 9% all the way to 15% or 16% depending on how poor a borrower's credit history is. These loans are available from mortgage bankers and mortgage brokers. CAUTION: Before considering this type of loan, be sure to review all terms and conditions of the loan.

If a borrower chooses a non-conforming loan, he or she can keep the loan for one to two years and then refinance into a normal lower-rate loan if all mortgage payments are made on time and all other debts are kept current. Many of these loans now do not have any pre-payment penalties (they all did in the past).

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