Applying for a mortgage can feel intimidating, and sometimes things don’t go as smoothly as you hoped. Understanding what challenges could arise can help you feel more confident and less nervous if an issue does come up. Working with an experienced mortgage guide is also key to reaching your goals, especially if you have credit challenges. They can support you and help you overcome any hurdles along the way to closing on your new home
Everything Comes Back to the 4 C’s
What are some of the most common challenges that borrowers face? We’ll explain by looking through the lens that lenders use every day–the 4Cs: credit, cash, capacity and collateral.
Your credit score helps lenders decide if they can trust you to pay back the money you’re asking to borrow. Of course, a higher credit score makes you look less risky to lenders.
It’s a smart move to check your credit score 3-6 months before you plan to apply for a loan. You can check your credit report for free at www.annualcreditreport.com. (Note this site will show your credit report but not your 3 credit scores; you can pay a minor fee to view your score from each credit reporting bureau.)
If your credit score is lower than you expect at the time you apply for a mortgage, you might qualify for less appealing loan terms (such as a higher interest rate) or not qualify at all. There are loan programs available for those with lower credit scores, but those with higher credit scores (such as 740 and above) can get the lowest interest rates with the least amount of points. (See also “Which Type of Mortgage Should I Get to Buy a Home?”)
You might decide to work on boosting your credit scores to qualify for better loan terms and then reapply in a few months. On the other hand, it might make sense to close on your purchase or refinance now, and then refinance down the road if your credit improves and the terms are favorable. Why?
Home prices could increase, and interest rates could rise. You might be paying a higher interest rate now if you currently have a mortgage, or you might be paying high rent now and missing out on tax savings from having a mortgage. If you can repair your credit quickly, that’s great, but don’t sacrifice paying more in rent, a current mortgage, or a higher interest rate or purchase price in the future just to bump your credit up a little. A good mortgage broker or loan officer can explain your options and help you decide whether it’s better to buy now or later.
Once you have started a loan application, your credit is essentially “under a microscope” during the entire loan process. You need to carefully consider any financial move that could potentially affect a lender’s decision to approve your loan.
Your credit is pulled at the start of the application. Lenders may check your credit again towards the end of the process (usually with a soft pull). If there is a dramatic difference between your credit score at the start of the loan application and your score at the second credit pull, it can cause a potential issue. Usually that happens if you missed a payment or applied for new debt.
Tip: Do not make any big purchases while you’re working on getting a loan, and don’t miss any debt payments. Keep your credit clean and try to keep your income coming in consistently. Do not start ordering furniture for your new house until after your loan has closed and been recorded by the county!
Cash to Close Challenges
The biggest issue related to your cash to close is sourcing your down payment. Lenders want to know where your down payment money is coming from, and they want a paper trail to verify it.
The longer you can keep money in the account where lenders expect it to come from, the better. Lenders usually want to see 2-3 months of history of cash funds, with account statements for verification. They want to know that you’re not getting another mortgage that they’re not aware of or borrowing large sums of money that you haven’t disclosed. They’re about to lend you hundreds of thousands of dollars, so they want to make sure they’re making a safe decision.
If you have savings ready for a down payment, leave the money in a savings account until you’re ready to close. If you have funds coming from a life insurance policy, either leave the money in the life insurance policy until a couple days before closing or put the funds in a savings account at least 2 months before applying for a mortgage and keep the money there. (This is called seasoning to lenders.)
If the funds are coming from a family member, let the family member keep the money in their account until closing. If, for example, Grandma sends you a big chunk of money during the loan process because she hears you’re about to buy a house, suddenly you have this big deposit, and you’ll have to show where it came from. An underwriter is going to flag that deposit. Grandma will have to write a letter for the underwriter explaining that she gifted you the funds. It’s not a big deal, but just another thing to do.
If you get a big tax refund, you may have to write a letter explaining where that money came from. These are not insurmountable issues. But if you plan, you can avoid these extra steps and make the loan process run more smoothly.
Tip: Deposits greater than 10% of your gross monthly income will likely be flagged and questioned. For example, if you’re making $5,000 a month, then deposits of $500 or greater will probably require a letter of explanation so the lender can provide a paper trail of the source of that money. Be prepared to offer a reasonable explanation, or just move the funds into the savings account early enough to allow for 2 months of statements to be generated.
Capacity to Repay Challenges
Employment verification is a common challenge to proving your capacity to repay the loan. If you’re working for a small company, it can be hard for the lender to verify your employment. Your boss has to verify your employment, so make sure they understand that you need their help verifying employment and to please respond quickly.
Losing your job would, of course, cause problems. Changing jobs or changing positions can also raise concerns to a lender.
Another issue with capacity to repay is doing anything to change your debt-to-income (DTI) ratio. Making large purchases and taking on new debt can change that ratio and derail your loan application.
For example, a borrower who was a hunter bought a new 4-wheeler right in the middle of the process of buying a house. (It was hunting season.) The lender told him he had to take it back to qualify for the new mortgage. All the borrower had to do was wait a couple of weeks, buy the house first and then he could go buy the 4-wheeler. It may be hard to wait on that exciting purchase (even during hunting season), but a big purchase can push up your debt-to-income ratio and disqualify you for a mortgage.
You want to strive to present consistent income while applying for a mortgage.
If you think you might retire in the next 6 months, don’t tell your employer yet if you’re trying to buy a house or refinance a mortgage, because they will put on the verification of employment that you are leaving that job in 6 months. And you might decide not to retire yet. We don’t advocate any sort of deceit, but understand how your situation will look to a lender. You want to keep things looking as consistent and predictable as possible.
Collateral has to do with the property you’re buying, because that property serves as collateral against the loan if you stop making payments. What happens if the appraisal comes back lower than the purchase price?
A lender is only willing to offer you a loan based on the fair market value of a property, as determined by an appraisal. You could end up with a shortage of money to pay for the property if the appraisal comes in lower than the purchase price.
As an example, if your purchase price is $350,000 and you were going to put 10% down ($35,000), your loan amount would be 90% of $350,000, which is $315,000.
If the appraisal comes in at $340,000 ($10,000 less than the purchase price), the bank will only loan you $306,000.
You have a couple of choices:
- You can cancel the purchase if you don’t want to buy the property anymore or you can’t afford to pay any additional cost out of pocket.
- You can try to renegotiate with the seller. If the appraisal came in $10,000 under purchase price, you could ask the seller to reduce the price by $10,000.
- You might try to meet in the middle; you ask the seller to come down $5,000 and you pay an extra $5,000 out of pocket. (This is assuming you have additional funds that are not required for closing costs and would not require you to take on new debt.)
- You can pay the entire $10,000 difference out of pocket and still proceed with the purchase. If the market is hot and the seller does not want to reduce the price, this could be a good option, as long as you have enough funds available. That’s $10,000 in addition to your regular down payment. In this example, that’s $34,000 + $10,000 = $44,000, in addition to the loan closing costs.
Tip: If the appraisal comes in high, that’s a wonderful thing and may be used in your favor. You can ask the seller to increase the purchase price by the higher appraised amount and credit you back the difference at closing. (The seller still gets the same amount of money.)Why would you want to do that? Because you can use the additional money to buy down your interest rate. You can get more bang for your buck by reducing your interest rate than keeping the purchase price the same. A good mortgage broker or loan officer can show you mathematically how reducing the interest rate can benefit you. (You cannot, however, use the additional amount towards a down payment.)
Try to Avoid Causing Delays
Delays in employment verification from your boss, proof of insurance from your insurance agent or from you responding to documentation requests could cause the loan process to take longer and for you to possibly lose an interest rate lock. Some delays are just out of your control, such as waiting for an inspection or appraisal or even new construction to be completed.
Avoid causing delays on your end by getting loan documentation to the lender as quickly as possible. Don’t argue with them; they’re trying to help you qualify for the loan and they want you to qualify. If you have questions or concerns about what you’re being asked for, then call your mortgage broker or loan officer. Sometimes there is alternate documentation you can provide if they ask for something that you don’t have, so just ask if you’re not sure about a request.
Do respond as quickly as possible and stay in touch, and you’ll increase the chances of your loan closing on time and successfully getting into your new home.
If you’re nervous about the challenges that you might face applying for a mortgage and want to talk to a seasoned loan professional, we can help.