5 ways to convince the bank you deserve a (better) home loan
We're all aware that, as a result of this mortgage PTSD, banks have raised the bar on what it takes to get a home loan. They know the riskiest borrowers are the ones whose income and assets were undocumented, and those who had no skin in the game because they hadn't put down a down payment. These are the folks who were the most likely to lose or walk away from their homes when the values plummeted.
Fortunately, the reverse is also true: The more you can prove that you pose a low risk of defaulting on your mortgage, the more likely you are to qualify for a loan. And even if you already have a good enough credit score to qualify for a mortgage, boosting your FICO score (by even a few points) to the magical prime loan qualifying range of 700-740 can get you a lower interest rate, saving you thousands.
1. Conduct an audit. Many prospective borrowers who know they have good credit just call the mortgage broker, submit the loan application, get their rate quote and start house hunting or get the refinance underway. But if your score is 690, a quick audit resulting in even a single correction or deletion of a derogatory item can get you an extra 10 points on your FICO score, saving you as much as a quarter-point on your interest rate! Order your annual complimentary report from AnnualCreditReport.com, and check for accounts that don't belong to you, or derogatory items that should have already "aged" off your report.
If you're in a rush, ask your mortgage broker to submit a "Rapid Rescore" request to the credit bureaus. Yvonne Hemmingsen, a licensed mortgage broker in Pleasanton, Calif., says that with a letter or documentation from the creditor as to the error, a consumer can get the bureaus to correct errors, but it takes two reporting cycles -- as much as two months. "With a bureau direct rescore submitted by a mortgage broker, on the other hand, the derogatory information should be deleted in less than a week," Hemmingsen says.
2. Pay down a few bills. Depending on how much debt you have, and how you reduce it, paying some of it down may boost your FICO score. But reducing your debt does double-duty in terms of helping you qualify for a home, in that it also decreases your debt-to-income ratio, which allows you to qualify for a larger mortgage. This takes some strategy, though - involve your mortgage professional in the conversation. They can tell you which bills, reduced by which amount.
3. Spread your debt around. A high FICO score isn't just a sign that you're good with money - in that case, debt-free people would have sky-high FICOs. But that's not how the scores work. FICO scores document that you have a habit of being smart AND active with your use of credit. In fact, the FICO algorithm targets an ideal credit utilization ratio of 30% - 30% of any given card carrying a balance, and 30% usage of your overall available credit.
If you're an airline miles junkie who uses one credit card to death and the others not at all, spread your debt around to all of your cards, targeting a 30% balance on as many cards as possible. This not only activates cards that are subject to being closed from non-use (which can reduce your FICO score by reducing your available credit), it also prevents any single card from looking like it's maxed out.
4. Get a gift. While banks require a downpayment for the vast majority of loan programs (there are some VA and profession-specific loans that still offer 100% financing) many buyers are taking this opportunity to buy with whatever savings they currently have, so long as it's over the 3.5% bare minimum. To get the very best interest rates, though, takes a full 20% downpayment.
If you've got a dear old Dad, generous grandparents or a doting childless aunt who's always trying to force cash into your hand (or your savings account!), this could be their time to shine. Most lenders will allow some or all of the down payment to come from a gift, as long as you can produce a "gift letter" from your benefactor(ress) confirming that you are family related and that the money is a gift, not a loan. Again, touch base with your mortgage pro to see what your particular loan program guidelines around gift funds are -- before you deposit the check!
5. Bump your down payment to 20% with a little help from your IRA or 401K. Currently, you can withdraw up to $10,000 from your Traditional IRA for your down payment on your first home without penalty (although you will incur income tax). You can withdraw as much as you want from what you've contributed to your Roth IRA without being taxed, and an additional $10,000 in Roth IRA earnings without penalty. With your 401K, it's a bit different -- some providers will allow you to borrow against your own account, then repaying yourself over time with interest.
If your alternative is borrowing from a lender what you could borrow from yourself, it makes sense to borrow from and repay yourself -- especially if you can borrow enough to put you over the 20% mark, so you can get a lower down payment on the entire mortgage balance. Consult with your CPA or tax adviser before applying retirement account funds toward the purchase of your home.