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Self-Employed and Getting a Mortgage: What You Need to Know

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Millions of Americans have taken control of their careers as entrepreneurs and freelancers. Unfortunately, traditional mortgage rules can deliver an unpleasant dose of reality for aspiring homeowners who are self-employed when it comes time to buy a house.

If you are self-employed, either full time or part time, and have plans to purchase or refinance a home, there’s a lot you need to know to prepare for the potential challenges ahead.

Who is considered self-employed

For mortgage lenders, the standard definition of self-employment is having 25% or more ownership in a company that you derive income from. This includes all types of businesses, from sole proprietorships to LLCs and corporations.

Independent contractors and freelance workers may be considered self-employed as well, even though you might not have ownership in the company that pays you. If you receive 1099s at the end of the year, chances are you are self-employed.

Why it’s harder to get a mortgage when you’re self-employed

For traditional employees, lenders use the gross income reported on a W-2 tax form to evaluate you for a mortgage. For example, if you make a salary of $60,000 a year, your lender can use $5,000 per month to qualify you for a mortgage loan.

For self-employed workers, the calculations are much different. Lenders take into account your business expenses when determining your income.

Let’s look at that same $60,000, only this time if you earned it as your own employer. Before the lender can determine your qualifying income, they have to look at all the expenses you are deducting on your tax returns — including meals and entertainment, cellphones, internet service and mileage for your vehicle.

Assuming you have $20,000 per year in expenses for running your business, a mortgage lender will deduct the $20,000 from your $60,000 gross income, and the $40,000 that’s left is the income that can be used to qualify. That is your net income.

If you are self-employed, you would only have $3,333.33 per month of income that could be used to qualify for a new mortgage. That equals a much smaller house, or a larger down payment.

Documents you’ll need to provide if you are self-employed

Getting a mortgage as a self-employed borrower requires a bit more documentation and explanation as well. But is possible to get approved with diligence, persistence, and in many cases, the help of a good tax professional or CPA.

2 years of personal tax returns: Lenders will want all the pages and schedules of your personal federal tax returns.

2 years of business tax returns: If you own at least 25% of your business and your company is a partnership, LLC or corporation, you’ll need to provide two years of business returns with all pages of the federal schedules.

Year-to-date profit and loss and balance sheet: Besides looking at filed tax returns for the two most recent available tax years, lenders will want to get an idea of how things are going this year. By getting a profit and loss statement through the most current quarter or month, they can determine if things are getting better, getting worse or staying about the same. The profit and loss and balance sheet can be self-prepared, so you don’t necessarily need to pay a CPA or professional tax preparer for these documents.

Year-to-date business profit and loss statement and balance sheet: In addition to seeing how much income is coming to you this year, lenders will want to see how the business is doing. These don’t have to be audited financials — like with the personal returns, a self-prepared version generated from bookkeeping software is usually acceptable.

Audited financials for year-to-date income: If you need this year’s income to qualify, but the tax year isn’t over yet, you might need to provide audited financials. This can be a costly option, but if you’re having your best year ever and need the income to qualify for a higher house payment, this is an option.

Most current 2 months business and personal bank statements: Lenders will look at your bank statements to determine how the money is flowing into your personal accounts. If you are using funds from a business account to make a down payment on a house, you may need to provide business bank statements as well.

IRS 4506-T transcript request form: In the bad old days, many borrowers were coached to manufacture tax returns to qualify for mortgages if they were self-employed. To prevent a repeat of that, most lenders will require you sign an IRS 4506-T form to verify the information you provided on your tax returns is what you filed with the IRS.

What lenders are looking for if you’re self-employed

You can only prepare properly if you have an idea of what lenders look for when considering your application for a mortgage. Provide extra explanations upfront for any details about your business income that will keep them from guessing, and give them more evidence that you have the ability to repay the loan.

Large increases or decreases in your income

Lenders will usually average your net income over a two-year period to determine how much income to use to issue a loan. Any large increases or decreases can be causes for concern and result in the decline of your loan application.

The biggest red flag for most lenders is a 25% or more decline in self-employed income from the prior year. The explanation may be simple: You might have started up a new branch of your company and incurred a lot of expenses that won’t continue in future, or perhaps you changed the structure of your company from a sole proprietorship to a partnership.

The important thing is to provide an explanation, and preferably a letter from your CPA for any one-time tax losses you were taking. That way, the lender understands the company is in good financial shape and the losses were not due to hardship.

The same is true for large increases. Unless there is an explanation or documentation that the most recent year’s increase in income was due to something that will continue into the future, the lender will probably average the most recent year against a lower prior year to be conservative.

Keep in mind they are looking at the income and expenses for both you and your business. If your personal income has risen substantially in the past year, but there was also a significant drop in your company’s earnings, lenders will want to know what’s going on with the company.

How long you’ve been self-employed

If you’ve been self-employed more than five years, there are programs that will allow you to get approved with just your most recent year’s tax returns. If you have one rough year, but have been in business for decades, an underwriter may be willing to make an exception if you can document prior year’s earnings, and show that the current year’s earnings are back on track.

Business funds for down payments on a home

Combining your business funds with your personal money can get tricky in mortgage lending. Lenders will want you to verify that using those funds won’t affect business operations or cash flow, and they may want your tax professional to write something to that effect.

If you can come up with your down payment without accessing the company’s asset accounts, lenders may waive the requirement for the business tax returns.

Type of business you are in

If you work in a business or industry that has seen rough days lately, or one that appears to be in early growth stages, lenders may scrutinize more carefully the reasons for your drops or rises in income. They might require more documentation or reduce the amount of loan they are willing to qualify you for.

Different types of loans for self-employed borrowers

Conventional

Conventional loans are generally the most sought-after to get the best rates and terms. Fannie Mae and Freddie Mac are the two of the largest purchasers of mortgage in the U.S. mortgage market and dictate most of the terms. Generally, they take into account the last two years of personal and business tax returns.

Freddie Mac makes an important distinction for business owners who are qualifying with a company that’s been in existence at least five years. The requirement for tax returns can be reduced to only one year’s worth of personal and business returns if you can provide a letter from your CPA or certified tax professional confirming your company has been in existence at least five years.

FHA

The FHA program requires the same two-year income history as Fannie Mae. However, since the credit score requirements are lower, self-employed borrowers may have more flexibility to get approved. Minimum credit scores can be as low as 580, versus the 620 required by Fannie Mae.

The requirement for business returns can be waived if your personal tax returns show your income has risen over the past two years, and none of the funds you’ll use at closing are coming from your business accounts.

VA

Self-employed military veterans will be required to provide the standard two years of tax returns, plus a year-to-date income verification.

The VA uses a “residual income” analysis, which looks at how much the veteran has every month after his total expenses including the new mortgage, are deducted from his net income. Depending on the size of the veteran’s family and the size of the house, self-employed military veterans may get the most flexibility in qualifying for a VA loan.

USDA

The USDA loan program offers loans for lower-income borrowers in rural areas. You might be surprised, though, by what properties in your area qualify.The standard two-year tax return requirements apply to USDA loan and underwriting and credit requirements are similar to FHA.

Final considerations for the self-employed mortgage applicant

First impressions are everything, and that’s especially true if you are self-employed and applying for a mortgage. If you know that your business had big changes in income over the past year, you have two choices: You can roll the dice and hope the numbers come up in your favor; or you can be proactive and provide explanations from your CPA and documentation to support all those changes. Regardless, you’ll want to work with a loan officer who has some experience with self-employed borrowers.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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Why Lying On Your Mortgage Application Just Isn’t Worth the Risk

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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It’s been more than a decade since the housing meltdown when “liar loans” were frighteningly common, and unfortunately the number of borrowers who lie on their mortgage applications is on the rise yet again.Leading up to the housing crisis, unethical housing professionals took advantage of loan programs that didn’t require income or asset documents, and encouraged borrowers to lie on their applications to meet the approval guidelines. That often meant pushing homeowners and homebuyers to borrow more than they could afford.

The Dodd-Frank Act of 2010 all but eliminated liar loans in the aftermath of the housing bust, but that hasn’t stopped lying on applications from making a comeback. The crime committed when lying on a home loan application is called mortgage fraud, and with new laws making it punishable with jail time and million dollar fines, it just isn’t worth the risk.

Why people lie on mortgage applications

There are a number of reasons someone might lie on a mortgage application. The two most common are fraud for housing and fraud for profit. We’ll discuss what each is and provide some examples of how they might work.

Fraud for housing

This type of fraud is related to consumers that make up or inflate information on some part of their loan application to get a home, or keep the home they have. Examples might include convincing an employer to write a “new job letter” with a salary made up to qualify, or trying to persuade an appraiser to come in at a particular value to support a cash-out refinance.

The primary motivation for this type of fraud is to either buy a home, or access some of the equity that has been built up on a home. Home equity is the difference between what your home is worth, and the balance of any mortgage financing.

Fraud for profit

Industry insiders such as real estate agents, loan officers, attorneys, appraisers and even title companies are usually the perpetrators of fraud for profit. They use the entire loan process to steal cash and equity from both lenders and homeowners. Because of the sheer magnitude of economic damage fraud for profit schemes do to local housing markets, the FBI focuses most of its resources on them.

In some cases, home buyers may be part of a real estate fraud scheme involving real estate agents, mortgage loan officers or appraisers to acquire multiple properties in a short period of time, with the intent to immediately flip them for sale at a profit. In more sophisticated fraud rings, sellers may buy and sell houses within a certain area to artificially drive up values.

Unethical loan officers or real estate agents may try to convince inexperienced real estate investors to participate in these schemes, and in many cases they may indicate that there is no harm in a little white lie. But mortgage fraud is mortgage fraud, and you don’t want to be on the other side of the law if the FBI begins scrutinizing an application.

We’ll explore the most common types of mortgage fraud, based on recent reports and studies by Fannie Mae and Corelogic.

Seven common lies on mortgage applications

Lies on a mortgage application don’t just include things like stating you make more money than you actually do, or that you received a gift from someone who isn’t really related to you. You can also commit fraud by leaving off information like properties you own with no loans on them.

Corelogic issued a Mortgage Fraud Report in 2018 listing the most common types of fraud being found on loan applications. Although they are ranked based on how frequently they occur, any type of mortgage fraud is considered a federal crime, and will put the applicant at risk of prosecution.

Lies about your income

If you’re misrepresenting how much income you make or embellishing your employment history to try to get approved for a mortgage, you’re committing income fraud. Your income carries a lot of weight when a lender is determining whether you’ll be able to repay a mortgage loan. In fact, your debt-to-income (DTI) ratio, a measure of how much debt you have compared to your pre-tax income, is just as important as your credit history.

Your employment history is also important, and lenders prefer that you have at least a two-year history of earnings at your current job, with steady pay and no gaps in employment. However, you can get a mortgage if you’ve just started a job, or have recently received a large raise.

Dishonest borrowers and their employers may generate job letters with inflated starting salaries, or showing a large raise with manufactured paystubs. The income allows them to meet the DTI requirements on houses they otherwise wouldn’t be able to afford.

The number of applications with evidence of income fraud rose more than another type of mortgage fraud according to Corelogic’s mortgage fraud report in 2018.

Lies about living or not living the home you’re buying

Occupancy fraud is when the applicant lies about how they plan to occupy the property to take advantage of lower interest rates or down payment requirements. When you fill out an application you indicate how you will occupy the property you are buying or refinancing. You may choose to live in the property as a primary residence; on occasion as a second home (commonly called a vacation home); or as an investment property that you intend to rent out to tenants to earn income.

Interests rates and down payment requirements are the lowest on primary residences, which may motivate an applicant to lie about living in a property, even if they are really going to rent it out.

Another example of occupancy fraud involves buying an investment property, but indicating it is a second home to get better rates and make a lower down payment. This is most common with out-of-state buyers who may eventually plan to retire in the location they are buying, but rent the property out until they reach retirement age.

Lying about an investment property you actually plan to live in is called reverse occupancy fraud. Current lending guidelines allow you to qualify for a mortgage using the market rent on a property you are buying as an investment property.

Buyers with a lot of liquid assets, but very little income, may commit reverse occupancy fraud so they can get the benefit of the rental income on the property they are buying to qualify.

Lies about who is benefiting from the transaction

Transaction fraud arises when one or more parties to a purchase or refinance transaction lie about why they are getting a mortgage, or try to influence people with cash or profit incentives to buy a property on their behalf.

When you buy a home, you typically sign a purchase contract agreeing to a sales price, and costs associated with the sale of the property. Everyone involved in the transaction has to agree to how much they will be paid, and disclose whether they are related to anyone who is buying, selling or representing a buyer or seller. If the parties agree to terms they believe are fair, and there is no relation either by business or family, that would be considered an “arms-length” transaction.

Lenders do allow financing on non-arm’s length transactions, but scrutinize them to make sure all the parties are working in each other’s best interests.

Reverse mortgages fraud is a type of transaction fraud that has been on the rise as reverse mortgages have risen in popularity. A reverse mortgage allows a senior citizen to access equity in their home in a lump sum, or to create monthly income and does not require a monthly payment.

A child or unscrupulous loan officer might convince an aging parent to take out a reverse mortgage with promises of investing the money, or offer them a large commission or bonus for buying a house with a reverse mortgage. The predators in these schemes are usually trying to earn large commissions, or take the cash from the reverse mortgage proceeds, and the seniors may not even be of sound mind to understand they are being taken advantage of.

Lenders perform thorough checks of contracts and parties involved, and may require higher down payments, or flat out deny a loan if they believe a non-arm’s length party is trying to coerce the borrower to take out a mortgage.

Trying to convince an appraiser to lie about a home’s value

When a home is placed for sale, the seller provides certain disclosures about the condition of the property and real estate agents agree on a fair market value. An appraiser is hired to inspect the property and determine if the agreed upon price is fair based on the recent sales of similar homes nearby.

Before the housing meltdown, lenders, borrowers or real estate agents could pick any appraiser they wanted. Unfortunately, as the housing market heated up during the boom years, appraisers were chosen based on their ability to “hit a value,” which lead to sales at inflated prices.

When the housing market collapsed in 2008, many of these homes dropped in value rapidly, resulting in loan balances being higher than their market value. This phenomenon was called “being underwater,” and resulted in a high rate of foreclosures, as homeowners found themselves with homes that were worth thousands, if not hundreds of thousands, less than their loan balances.

To prevent this problem in the future, the government passed appraisal independence requirement laws that require lenders use a random rotation of appraisers. Many lenders now employ appraisal management companies with a roster of dozens of appraisers in different housing markets, and lenders, borrowers and real estate agents risk regulatory and legal action for attempting to influence an appraiser’s opinion of value.

Not disclosing other real estate you own

Many borrowers mistakenly assume if they own real estate with no mortgage they don’t have to disclose it on the application. In other cases, they may intentionally leave the property off of their application so they are eligible for first time homebuyer programs.

Whatever the reason, this is a form of fraud, and could result in a loan denial, even if the loan is initially approved. Lenders perform a series of quality control measures, which include checking national public records databases to be sure your name or social security number are not tied to ownership of a real estate anywhere else.

Even if you don’t have a mortgage on a property, you are responsible for paying property taxes, and in most cases maintaining homeowner’s insurance. Lenders will take the annual amounts and divide them by twelve, and count the monthly payment against you when you are qualifying for a new loan.

Many of these quality control tests are done right before closing, so it’s just not worth lying on your application by omitting real estate you own, because you could end up with an 11th hour closing crisis, or worse a declined loan.

Stealing someone else’s identity to get a mortgage

According to a study by Javelin Strategy in 2017, a research based advisory firm, 16.7 million people in the U.S. were affected by some form of identity theft in 2017. Examples of identity fraud include manufacturing a social security number, or using someone’s — such as an elderly parent’s — identity to obtain a home loan.

Given how long the average loan process takes and how intensive the identity checks are, it’s the rarest form of mortgage fraud. However, if you have an elderly parent, and they indicate that they are receiving notices about past due credit that they never opened, you may want to take action immediately to determine if someone is testing the waters with their identity information.

Lying about the source of down payment funds

One of the first red flags a lender will look for on your bank statements is large deposits. Lenders want to know where the funds for your down payment came from for a few reasons.

The first is, they want to make sure a third party is not providing funds as part of a straw-buyer scheme. A straw-buyer is usually someone with good credit and stable income, and is paid a fee to take out a mortgage on a home they don’t intend to live in, or make payments on.

The buyer may be given the down payment in cash, or as a gift by fraudulently filling out a gift letter indicating a family relationship with the buyer. Because lenders don’t generally request proof of relationship with gift funds, this type of asset fraud is hard to track, and may not be discovered unless there is a fraud investigation later.

To avoid having to document a large cash deposits, more sophisticated straw buyers schemes may involve mortgage lenders producing forged bank statements. The straw buyer may also be given small amounts of cash by a real estate agent or investor to deposit over time, making it look like they are saving up for the down payment themselves.

The other red flag with large deposits has to do with money laundering. According to a report from Accuity, a global risk insurance company, real estate money laundering schemes reached $1.6 trillion a year across the globe.

Crime syndicates and drug cartels try to make their businesses look legitimate by using the funds derived from illegal activities to make “normal” purchases, such as buying real estate. Anti-money laundering measures are designed to scrutinize any funds used to buy and sell real estate, and watch for patterns of deposits that would indicate an individual is trying to stay just under the threshold for cash deposits that might trigger a money laundering investigation.

Why it’s not worth it to lie on a mortgage application

There are a number of reasons you should avoid lying on an application. The consequences are severe, and laws passed since the housing crisis deal more harshly with incidences of mortgage fraud than in past years.

You could go to jail and be fined

Under current U.S. federal and state laws, a conviction for mortgage fraud could result in a 30-year federal jail sentence, and up to $1 million in fines.

Your loan could be called due

If a lender finds that you committed fraud, they have the right to call the entire loan balance due. If you are unable to sell the home, you could end up with a foreclosure, and the lender could sue you for any losses they incur on the resale.

Your employment options could also be severely limited in the future. Businesses take financial fraud very seriously, especially when they are making hiring decisions. If you have a conviction on your record for any type of mortgage-related fraud, your ability to get a job could be severely limited.

Financial service employment will be virtually impossible, and employers may not consider you for any position that puts you close to a source of money, even if it’s just running a cash register at a convenience store or using a computer system to input food orders at a restaurant as a waiter.

What to do if you spot fraud in your neighborhood

If someone has asked you to lie on a loan application, or you know someone in your neighborhood who has indicated that a “little lie” won’t hurt anyone, you should be aware of the proper authorities to contact. The cost of mortgage defaults due to fraud is often paid by homeowners in the neighborhood when the loans inevitably default once the scheme is discovered by authorities. In large scale mortgage fraud rings, like the ones that occurred during the housing meltdown, taxpayers can end up on the hook for bank bailouts.

You can take action by contacting the following agencies to prevent or investigate mortgage fraud:

U.S. Department of the Treasury Financial Crimes Enforcement Network: Provides information and resources on mortgage fraud.

The Department of Housing and Urban Development (HUD): Besides providing information about homeownership, you can contact a HUD counselor. They are trained to spot mortgage fraud, and may have resources for contacting the appropriate authorities in your area.

The Federal Bureau of Investigation (FBI): The FBI does investigate financial crimes involving mortgage fraud, so you can contact them if you feel there is a major fraud scheme going on in your neighborhood or town.

Final thoughts: Lying on a loan application is not worth it

Lenders have a great deal of responsibility for making sure loan applicants can repay their mortgages. Besides making sure you have the income, assets and credit to support your loan request, lenders need to verify the documentation provided is valid and verifiable.

There are a number of different reports lenders run to protect themselves from making fraudulent loans, because they can be asked to buy back a loan if an audit by a regulatory agency discovers they didn’t take proper fraud prevention measures. If any housing professional suggests that you omit or lie about something on your application, notify the proper authorities. It’s not worth risking jail time, million dollar fines or becoming unemployable because you lied on a mortgage application.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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Don’t Apply for New Credit Before Your Mortgage Closes

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Purchase agreement for house

When you are in the process of buying a home, it’s easy to get ahead of yourself. You start shopping for all the furnishings you’ll need, lured by all the “same-as-cash” credit offers you’ll see at home-improvement stores, furniture retailers, and bed and bath shops.

The 10% discount you get by signing up might be a great savings for that purchase, but it could also cost you your mortgage, if you haven’t closed yet.

Lenders perform a variety of checks on your accounts up until the day of your closing. Any changes to your income, credit or money in the bank could not only delay your closing — it could turn a loan approval into a denial.

We’ll discuss why you shouldn’t apply for new credit before your loan closes, and suggest what to do if you already did.

Why opening new credit before closing is bad

Mortgage approval is contingent on your financial information from the day you submit the application until the day the house is recorded into your name. Many first-time homebuyers don’t realize the verification process is ongoing, even after you get the initial OK. Lenders will even double-check your employment and credit — the two biggest factors affecting the decision to lend you money — right before closing, and in some cases even the day of closing.

Below are some of the reasons why applying for new credit before closing could create problems for you before closing.

Your debt-to-income ratio could rise too high

Your debt-to-income (DTI) ratio is a measure of the total debt you owe divided by your before-tax income. Depending on the lending program you apply for, the DTI ratio maximum is anywhere from 41% to around 50%.

Your loan officer won’t usually go over what your DTI ratio is — if you’ve gotten a loan approval, you can safely assume you meet the guidelines. However, you may be right on the borderline of the maximum for your mortgage; if a new credit account balance pops up, the resulting monthly payment could you push you over the limit.

You could get a new monthly payment on your report

Many retail home goods stores offer “No payment due for 12 to 24 months” credit lines, giving buyers the impression that there will be no payment counted against them since it is the same as a cash purchase if you pay off the balance within the specified time period. However, these accounts don’t mean “no payment” to a mortgage lender.

If the creditor doesn’t report a monthly payment, the underwriter will have to calculate an estimated minimum, which may be as high as 5% of the balance of the account — so that $2,500 furniture account could add a $125 per month payment to your total debt, even if you aren’t required to make a payment to the creditor for 12 to 24 months on a “same as cash” incentive offer.

Your credit score could drop

It can take a while to find a home, and credit reports are generally only good for 90 days. If you don’t find a home and close within that time frame, your lender will have to pull a completely new credit report.

If you’ve racked up some credit cards or even inquired about new credit several times, your score could easily drop. The lower your score, the higher your rate will be, and even if you’ve locked in your interest rate, if your score drops because you charged up new credit, you’ll be stuck with whatever the rate and costs are for the most current credit score.

You might have to document your assets again

Don’t be surprised if a lender suddenly asks for some updated bank statements if you recently applied for new credit. Some borrowers are given bad advice to charge up their credit cards to use for a down payment, but credit cards have never been an acceptable source of a down payment.

The only type of borrowed money you can use would be against a fixed asset like a car or boat, and even then you’ll have to provide a lot of documentation to show how much the asset was worth, confirm you owned it at the time of the loan, and show the transfer of all the money from the lender.

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How lenders track your credit during the loan process

When you get approved for a home loan, mortgage companies are committing to lending you hundreds of thousands of dollars payable over a very long time, in most cases 30 years. Because of that, they need to make especially sure that at the time they make the loan, they can demonstrate that you have the ability to repay it.

If for some reason they make a loan you can’t afford, they face consequences from regulatory agencies, and ultimately lose money incurring the legal costs of a foreclosure. That’s why they have policies that pay special attention to how you manage your credit during the loan process.

Initial credit pull

When you apply for a home loan, one of the first things you lender will do is run an initial credit report to take a look at how you manage your credit. Sometimes the information on the credit bureaus can lag a few months, so if you recently applied for credit, make sure the balances and payments are reflected on the loan application you receive from your loan officer.

If not, provide your most current statement so the loan officer can accurately pre-qualify you for a mortgage.

Pre-closing soft pull

Once your loan approval is provided, there will be conditions that need to be met before your closing papers can be scheduled. Your loan officer will let you know if you need to provide anything, such as updated pay stubs or bank statements, before closing, and you’ll need to finalize things like your homeowner’s insurance company.

However, there are things that will be happening behind the scenes that you need to know about. One of the most important is the “pre-closing soft pull.”

A “soft-pull” is simply an update to track any activity on your credit since the initial approval. If your balance rises for something small, like charging your appraisal fee to a credit card, you won’t have anything to worry about.

What to do if you’ve already applied for new credit before closing

If you’ve already applied for new debt before your closing, don’t panic — just get the terms of the loan as soon as you can to your loan officer. The sooner you do, the sooner you’ll know if you have to take any drastic measures to fix any qualifying issues that may come up.

If there is a problem, you can take the following immediate steps.

Contact your loan officer immediately

Lenders are in the business of making loans, and the more proactive you are about communicating about any changes to your credit, income or money you have for a down payment, the sooner they can come up with a solution to keep your purchase from falling apart.

Get the terms of your new payment in writing

If the account is brand new, you’ll need to get something in writing as soon as possible that verifies what your new monthly payment will be. If you opened a deferred payment account, at least get something showing the balance so the underwriter can calculate the minimum payment that will be counted against you.

The lender will need to get it added to your credit report as soon as possible, and that process can take several days, since they have to coordinate with a third-party credit reporting agency.

Be prepared to pay it back and close it out

If you don’t qualify because of the new debt, the best plan is to pay if off and close it out, or return the items and get as much of a refund as you can. If you don’t have the assets to do that, you may have to make a painful phone call to a relative to get them to gift you money to pay it back, or you may be living on that brand new couch in their living room when your home purchase loan is declined.

You may have to switch loan programs or pay a higher rate

As mentioned above, not all DTI ratio requirements are the same. If you’re approved for a conventional loan, you’ll have a hard stop at a 50% DTI ratio, and even a fraction of a percentage over that will result in a loan denial.

You may have to switch to a more lenient loan program like the one the FHA offers, but that will mean a new approval, and potentially a new appraisal that meets the more stringent property guidelines required by the FHA. That is also the case if your score drops after updating an outdated credit report — conventional loans won’t be approvable below a 620 credit scores, while FHA will give you flexibility down to 580.

Either way, be prepared to jump through some extra hoops to undo the damage that applying for credit before closing can do to your loan approval.

Final thoughts: Avoid opening new credit until keys are in your hands

The best rule of thumb is to limit your credit use until you’ve got confirmation that the title company has recorded you as the owner of your new home, and you have the keys in your hand. If you have an emergency like a car that breaks down, or incur a major medical expense that you don’t have the cash to cover, talk to your loan officer about strategies to avoid any last minute crisis with your home loan closing.

This article contains links to LendingTree, our parent company.

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Denny Ceizyk
Denny Ceizyk |

Denny Ceizyk is a writer at MagnifyMoney. You can email Denny here

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