Home buyers breathe a sigh of relief when they get their home loan pre-approval from their bank or mortgage lender. After all, that letter of commitment from the lender means they are qualified to purchase, and the hunt for their new home can seriously begin.
But pre-approval is not a guarantee that the lender will approve your mortgage loan. Until the last loan document is signed and the loan is funded, nothing is set in stone.
Home buyers can be turned down for mortgage loans after obtaining a pre-approval if their income or credit conditions change.
To make sure this doesn’t happen to you, it’s important to avoid the “Big Three” credit mistakes once you have applied for your mortgage.
Don’t Close any Major Credit Accounts
Mortgage lenders will examine your financial status — including your income and credit report — to determine your creditworthiness. One factor they analyze is known as the debt-to-credit ratio, in which they calculate your debt and compare it to your current credit limit for revolving accounts (i.e., credit cards).
Lower is better when it comes to the debt-to-credit ratio for home buyers — and closing your credit card accounts will actually increase the ratio.
For example, let’s say you have a $10,000 credit limit with a debt balance of $2,500. Your ratio would be 25 percent:
$2,500 ÷ $10,000 = 0.25 or 25 percent
Now, let’s say you decide to close an unused credit account with a limit of $5,000. Your total available credit has dropped, so your ratio will actually go up to 50 percent:
$2,500 ÷ $5,000 = .50 or 50 percent
A change like this could cause a mortgage lender to have second thoughts about home loan approval, or they could force you to pay down your current balances in order to get pre-approval.
Don’t Pay Off Your Car Loan
Based on the debt-to-credit ratio information above, home buyers might think it would be a good idea to reduce their overall debt obligations. However, paying off a car loan after receiving your mortgage pre-approval is a risky mistake.
Sure, your total amount of debt will be reduced. But a large portion of your credit score is determined by your debt repayment history, which includes your current car loan. A solid history of repayment benefits your credit score. By paying off the loan early, your score could actually drop.
It will also reduce your liquid assets (cash). For many home buyers, mortgage approval requires that you have a specific amount of cash assets available at the time of closing.
Don’t Accept Cash Gifts or Repayments
Does a friend owe you some money? Or are you expecting a large cash gift? Home buyers must be careful about making large bank deposits, as lenders could mistakenly consider them loans. This can throw off your debt-to-credit ratio, hurting your chances for mortgage approval.
If you must accept a large sum of cash — for down payment assistance, perhaps — be prepared to answer questions about the deposit. Typically, only family members can gift funds to home buyers, so be sure your lender has approved the transaction. Finally, make sure you have proper documentation — such as a gift letter — that will document the source of the funds.
The Edie Israel Team provides professional representation for Southern California home buyers and sellers. Our reputation in Yorba Linda and the surrounding communities is exceeded only by our commitment to exceptional service to our clients. Contact us today for more tips to ensure your success as a home buyer or seller.