Polish the “5 C’s of credit” before you buy a home
by Brian Flock
Market conditions require better preparation before making an offer
Buying a home in San Diego is more complex than ever. Yet responsibility for navigating the lending process remains squarely on the shoulders of the borrower. The lending “game” may have been easier in the past but home buyers have no choice but to play by today’s more challenging standards.
I regularly hear stories of frustrated borrowers that are experiencing pain with today’s stringent lending requirements. Gone are the days of easy money with no-documentation and subprime loans; and “appraisal shopping” to match or exceed an offer price. In fact, most lenders are being more restrictive on conforming loans than what conforming loans regulations require.
Alas, borrowers’ need to adapt to the changed circumstances by polishing their “5 C’s of credit,” ideally before seeking and loan. Borrowers also need to stay flexible with the extensive requirements that they will experience from loan underwriters (i.e. credit risk reviewers) who are the primary judges of a given loan application.
Character
Underwriters evaluate the borrower’s “character” (i.e. integrity) for paying back the loan. This typically starts by looking at the middle FICO credit score from the three major reporting agencies. Options for those without a “good” FICO score (i.e. 700-750 or more) have been reduced substantially as a result of the lending market crisis.
Borrowers should take immediate action to any erroneous reports of late payments, bankruptcies, collections, and judgments as these can have a dramatic affect on FICO scores.
Credit report errors can be contested and removed from each of the reporting agencies. This requires patience and up to 30 to 45 days of processing but can be done online at:
Capacity
Sufficient cash flow is what defines the buyer’s “capacity” to repay a loan. However, items in the past that were taken based on written statements will now likely require extensive documentation. Self-employed individuals will need to provide at least two years of tax statements with all requested supporting documentation, no matter how onerous.
Whereas some loans in the “boom” period allowed debt ratios to be over 40% of gross income, current conforming guidelines are back to maximum housing obligation of 28% with all debt needing to be less than 36%.
Some types of income will likely not be considered at all such as secondary income that will continue for less than three years (e.g. grants); non-cash benefits; inheritances; and lawsuit settlements. Only a portion of rental income will be considered, usually 75% (or 90% in the case of FHA loans).
Capital
Net worth—especially liquid assets such as bank accounts, stocks and bonds—will be considered as available “capital” to help ensure that you will repay the loan. Capital, if substantial, can also be a somewhat compensating factor for other deficiencies in an application.
Collateral
“Collateral” (i.e. the assets to secure the debt) has become one of the greatest sources of loan frustration in the current San Diego housing market. This is because (artificially?) low housing inventory has resulted in many offers that exceed appraisal values. Further, new regulations have taken great strides to eliminate “appraisal shopping.”
Lenders simply cannot reasonably be expected to lend where their exposure is increased by an offer that exceeds the appraisal value.
Conditions
“Conditions” is a catch-all phrase for the lender’s view of the borrower and the general economy. Conditions are really internal policy guidelines and vary by lender.
There is little value in fighting an underwriter’s view of your borrowing conditions if your situation is against internal policy.
Instead, seek out a lender who may be more attuned to your situation.
Play by the new lending rules and polish your “5 C’s of credit” before you need them to shine.