Red Flags to Consider When Getting a Mortgage

Buying a house can be one of your most wonderful experiences. It can also often be one of the most stressful.

Getting a mortgage? That process is not usually considered wonderful, but it doesn’t have to be a stressful experience if you prepare.

While being ready to apply or having gotten pre-approved for a mortgage may provide you an understandable sense of relief, your mortgage is not a done deal until you sign your closing papers.

Be careful! Whether you are buying a new home or refinancing your current one, certain missteps might give the underwriter the impression that you will not repay your loan and could jeopardize your loan status.

Pre-qualified vs. Pre-approved

Mortgage pre-qualification and mortgage pre-approval may sound the same. They are, however, completely different.

Pre-qualification entails a basic overview of a borrower’s ability to get a loan. You, the borrower, verbally provide a mortgage lender with information about your income, assets, debts, and credit, but you do not need to produce any paperwork to back it up. In return, you receive a rough estimate of what size loan you can afford, but this process doesn’t guarantee that you will be approved for the loan when you want to buy a home.

Pre-approval is an in-depth process that involves a lender running a credit check and verifying your income and assets. Then, an underwriter does a preliminary review of your financial portfolio and, if all goes well, issues a letter of pre-approval—a written commitment for financing a loan up to a certain amount. A pre-approval letter shows home sellers that you are a serious buyer and can strengthen your home purchase offer.

Earnest Money

During the home-buying process, you are almost always required to provide funds that signal serious intent to buy a property; these funds are called an earnest money deposit.

In most cases, earnest money is delivered when the sales contract or purchase agreement is signed, though it can also be attached to the offer. The agents for the buyer and seller negotiate the required amount of earnest money, which averages between 1% and 3% of the home’s price. The exact amount depends on what’s customary in a particular market. Once deposited, the funds are typically held in an escrow account until closing, at which time the deposit is applied to the buyer’s down payment and closing costs.

Moving Money Around? Don’t!

To get pre-approved, you must show you have enough financial reserves to afford both the down payment and the closing costs. (Presenting your mortgage lender with bank statements is the easiest way to do this.)

Nonetheless, for your loan to be approved, it still needs to go through underwriting while you are under contract. Because the underwriter will check to see that your finances have remained the same, you should not make large deposits or withdrawals while you are in the process of buying a house. Shifting large amounts of money out of—or even into—your accounts is a huge red flag.

Report Any Gifts

If you have received a gift for your down payment, make sure you discuss how to document it with your mortgage officer at the time you apply.

Receiving your down payment as a gift is not a deal-breaker in getting your mortgage application approved, but the source of the funds and the nature of the deposit needs to be discussed to avoid problems with processing your application. Most lenders will want to see a gift letter and a bank statement showing the gift amount from the owner.

Beware Changing Jobs

Mortgage lenders like to see at least two years of consistent income history when pre-approving a loan. Consequently, changing jobs while you are under contract on a property can create a big issue in the eyes of an underwriter.

Try to wait until after you have closed on your house to change jobs. If you are forced to switch jobs before closing, you should alert your loan officer immediately. Depending on the lender, you may simply need to provide a written verification of employment from your new employer that states your job status and income.

Two other special situations are being self-employed or working on commission.

There are no special requirements that make it harder for self-employed people to get a mortgage. Self-employed mortgage borrowers can apply for all the same loans other employed borrowers can. You are held to the same standards for credit, debt, down payment, and income as other applicants.

The part that can be difficult is documenting your income. Proving your cash flow as a business owner, contractor, freelancer, or gig worker can require more paperwork than for W-2 employees. But as long as you meet loan guidelines and can document steady, reliable cash flow, being self-employed should not stop you from buying a home or refinancing.

If you receive commission income, you can use it to qualify for a mortgage as long as the proper documentation is shared with your loan officer to verify the income. Before you begin your mortgage application, be sure to gather two years’ worth of W-2s from your employer.

Do Not Make Any Changes to Your Credit Profile

Because your mortgage lender pre-approved you with a particular credit profile, you do not want to do anything that could change it. The slightest change in the wrong direction could change a pre-approval to a declined loan, or, at best, delay closing.

Do not close any credit accounts. Even though it may seem that with less credit you are not as risky in the lender’s eyes, closing accounts has the opposite effect. A significant part of your credit score comes from your credit history; proving that you have been making payments on time for the course of a long period helps.

The way FICO calculates your score can be confusing, as can the way the credit reporting system works. Unintentional mistakes or changes you may make in the name of credit improvement are not that easy to correct and could affect your score negatively if they are counted as derogatory items.

Besides, not all derogatory items as they are currently reported are hurting your score or mortgage approval.  (Leave it up to your loan officer and/or credit consultant to advise, if necessary.) In fact, do not make any changes to your credit profile at all without talking to your trusted advisers.

Do Not Take Out Any Other Loans

Auto, personal, and student loans all have one thing in common: they increase your total debt load. As a result, they can also affect your chances of being approved for a mortgage. Also, any new credit hurts you until you have a proven track record of payment.

When you apply for a home loan, lenders will consider the amount of debt you currently have. They will compare your recurring monthly debts to your gross monthly income. This comparison is known as the debt-to-income ratio, which has become one of the most important qualification requirements for borrowers in the current lending environment.

Do Not Make Large Purchases on Credit

Furnishing your new home or putting a new car in your new driveway may feel tempting, but you should avoid making any large purchases on credit. Large purchases raise your debt-to-income ratio and add inquiries to your credit report. These inquiries can lower your score and raise a red flag to lenders.

A home equity line of credit works like a credit card, and many of the same rules apply. Making purchases on your home equity line of credit affects your debt-to-income ratio. Plus, it can indicate to a lender you are relying too much on credit. You should not rely on credit when you apply for a mortgage. Show the lender that you have enough income to live on the money you make—not the credit cards or lines of credit you have.

Lenders use your credit score as a risk-assessment tool. A higher score indicates a lower risk for the borrower. And the reverse is true—a lower score indicates a higher risk for the lender. So, you want to do everything possible to protect your credit score when shopping for a mortgage loan.

Conclusion

It is always good to be prepared. As always, see a mortgage consultant or financial advisor for help.