When it comes to securing a loan to buy a home, your credit rating is the most important factor that determines how much you can borrow – and how much you will pay to borrow it. From the lender’s point of view, “good” credit means you have been fiscally responsible, so there’s less risk in lending you a large sum of money. To assess your creditworthiness, think like a mortgage lender and ask yourself these three questions:
How’s your financial character?
Have you been disciplined about repaying debts? Do you have a strong personal credit history? Your financial character is represented in your credit score – also referred to as a your FICO score. You are entitled to one free credit report (not score) per year, and you can dispute – in writing – any errors you find on it. Your score, ranging from 300 to 850, is based on an analysis of the amount of credit you have available versus the amount of credit you are using, your current account balances and how timely you are in repayment. A bank or mortgage company isn’t interested only in your past ability to pay. It wants to estimate how likely you are to honor future obligations.
Do you have a safety net?
Banks make money by lending money, and they can’t do that if you don’t make your payments on time, or if you default entirely. When assessing your creditworthiness, a bank looks at your paycheck to make sure you earn enough to make monthly repayments. But it also wants to know what you will do if you experience an economic downturn. How will you make payments if you lose your job or have a medical emergency? Do you have a reserve of savings … assets you can sell to meet your repayment obligations … access to cash outside of your paycheck, like stocks or CDs (certificates of deposit)? I can’t tell you how many good citizens have told me heartbreaking stories of losing their homes because they hit a bump in the road and didn’t have a cushion.
What are you offering to secure the loan?
Here’s the ironic thing about a mortgage: You borrow money to buy a house … and then you don’t really own the house. Until your mortgage is paid in full, the bank holds your home as collateral against the money you have borrowed (and are repaying with interest). If you fail to make payments, the bank can step in and foreclose on the property. If you default on your part of the agreement, the bank is allowed to try to recover its financial investment by taking ownership of the property. The bright side here is that banks and mortgage companies really do not want to be property owners. The downside is that if homeowners get into trouble, mortgage companies will do whatever they can to extend payments. They’ll increase the amount of interest the homeowners pay and avoid taking possession of the property. That’s why you see so much talk these days about short sales, loan modifications and foreclosures.
A good lender will take a deep look at the full credit profile of any applicant. Providing all the information your bank asks for can be frustrating, but the process is designed to protect both parties. If a loan seems “too good to be true,” it probably is. Unscrupulous lenders who offer “easy money” prey on uneducated consumers. As the real estate market recovers and buyers become confident again, be smart and proceed with caution. Your home is the biggest investment you will ever make. Being smart about your mortgage lets you plan for your home to be an investment in your future.