Making the Cut: What Lenders Look For
Take matters into your own hands to remove the sting of mortgage
A lender wants two things: to sell you a loan and to do it with
the least risk possible. The key to success is to be steady and
consistent in repaying loans. Each lending company has a variety
of products (loans), all with different rules and costs
(interest rates, points and fees). The better your credit, the
less risk the lender perceives and the less a loan will cost
What do lenders look for? "The first and most common answer is
your credit score. They also look at employment history, debt
history, liabilities, your job, how much you make," says Ron
Culver, account executive for Webster Bank, a Connecticut-based
wholesale mortgage company. "There are other small
things—bankruptcy history, collection history. A 'lack of
credit' is an unknown. This person doesn't use credit, and we
don't know if they are going to be responsible if they do."
To assess the risk involved in lending to you, lenders piece
together the story of your financial life, your spending and
payment habits over the last few years, says David Rubinger,
spokesman for credit reporting firm Equifax. Try to see your
application through a lender's eyes to assess the strengths and
weaknesses of your story. Anticipate problems—a gap in
employment history or late bill payments—and include a brief
letter of explanation. You may have had an illness, for example,
a divorce, a death in the family or a period of searching for
work before landing a job.
Tell your own story by collecting supporting evidence.
Well-prepared applicants are the most successful, says Vicki
Rosenthal, home loan underwriter (she analyzes applications and
decides which to accept and reject) with the private Mortgage
Guaranty Insurance Corporation (MGIC).
A lender's ideal: The perfect loan applicant
- Credit over two years: A steady history
of on-time payments on different types of loans. Bank cards with
credit to spare. Numerous credit inquiries in the six months
before applying for a mortgage can hurt your credit score.
- Employment history: Two years (no gaps)
in the same line of work.
- Housing payments: No late payments in
the last 12 months; a maximum of one in the last 24 months. The
lender's thinking: A borrower who has a history of making
housing a payment priority will make a housing loan repayment a
- Liabilities: To qualify for the best
rates, liabilities—car payments, credit card payments, mortgage
loan, student loan, alimony, child support and the
rest—shouldn't amount to more than 42 percent of your income,
says Webster Bank's Culver.
- Assets and reserves: An amount equal to
at least two months' mortgage payments, including principal,
interest, taxes and insurance. Three months is better; some
loans want up to six months' reserves. Other assets—pensions,
IRAs and CDs—can be included, but they are calculated at 60
percent to 70 percent of their value, to cover liquidation costs
and early withdrawal penalties.
But if you're not perfect...
Having no credit is not an impossible obstacle. Plenty of loans
exist for such nontraditional borrowers, says underwriter
Rosenthal, who has approved many first-time home-buyers' loans.
If you happen to be a nontraditional borrower, tell your story
by documenting transactions with people who have extended you
services: a childcare provider or a landlord, cell phone
carriers, cable service, utilities, car insurance—none of which
appears on a credit report. Include names, addresses, account
numbers and phone numbers.
"The more prepared you are at application; the less follow-up
you'll need to do," Rosenthal says. "A good application
presentation makes a huge difference."
Since your loan application will be viewed by people you'll
never meet, your winning personality alone won't be enough to
inspire confidence in your ability to repay a loan. Mysteries in
your credit story may be interpreted negatively. The letter of
explanation (keep it brief) is the best friend of the home buyer
whose application veers from perfection. Scan your loan
application for consistency in every detail with what's in your
credit reports and explain any variations in your letter. Look
for flaws, errors or a place where timelines don't exactly meet.
(You left school in June, for example, and started work in
November.) Include a good reason for the missing time period in
There's another home-buying myth that Rosenthal wants to
demolish: "One of the requirements to buying a home is not that
you have to save 20 percent for a down payment," she says.
"There are [loan] programs out there and insurable programs for
up to 100 percent of the value and beyond, based on your
What a 20 percent down payment does buy you is the opportunity
to avoid paying for mortgage insurance, which protects the
lender in case of a default.
Loans are offered, also, for those with damaged credit. The
downside is, they'll cost more. "Derogatory credit doesn't
necessarily mean you are not going to be eligible," says
With poor credit, however, your best friend is time, says
Heather Greer, spokeswoman for Experian, a credit reporting
firm. Positive information stays on your credit report
indefinitely. Bad entries live for up to seven years, but carry
less weight as they are replaced with a stronger record.
Inquiries by merchants into your creditworthiness remain for two
"It's important to take a peek at your report so there's enough
time to make changes," Greer says. "Do this at least a few
months before going into a lender. Then you can say, 'Yes, I may
have had this late payment, but for the last three or six months
I've been paying on time and everything is good.'"
"Pay off what you can," adds Equifax's David Rubinger. "The more
you can pay off your accounts and pay regularly, the more it
will help your score. If you have many inquiries, it can
potentially impact your score. But paying your bills on time and
paying them off as much as possible is a more important factor.
You should not open new credit cards if you don't need to
increase your available credit—to a lender, this means that you
have all this extra available credit, making you a greater
The big score
To tell your story right, get copies of your credit reports.
Three national agencies,
, collect and
report credit data. Their reports aren't identical, so get all
Fortunately, that just got easier. With recent passage of an
amendment to the Fair Credit Reporting Act, each agency must
give consumers one
annually. The law is being rolled out through
the year, starting in the West in December, the Midwest in
March, the South on June 1 and, finally, in U.S. territories and
Eastern states on Sept. 1, 2005. See a map of states and
roll-out dates and apply for free credit reports at
Annual Credit Report.com
, a Web site launched by the
You'd also want to buy—this one's not free—your credit score, a
three-digit rating of your creditworthiness. The higher your
score, the lower the interest rate you command. According to
Rubinger, about 70 percent of lenders use the FICO scoring
system. Several firms, including the credit reporting agencies,
use their own systems—similar to but different from FICO. To
ensure you purchase the same score (or scores) as your lender,
ask the lender you're thinking of using which they prefer.
Scores start at under $10.
Finally, knowing your story lets you shop for the right lender.
Armed with your new self-knowledge, make lots of phone calls to
learn which lenders have the most choices, the best rates, the
lowest fees, the speediest processing times. Don't be shy about
describing your situation. If you have had credit problems,
consider avoiding lenders whose loans require sterling credit.
"Compare what's available, what types of programs they have,"
says Rosenthal. "If you don't know what the programs mean, they
can get you the disclosures [fine-print rules and
"With your homework done, you'll be your own advocate, there
won't be as many surprises," she says. You'll be glad that you
learned to see yourself through a lender's eyes.