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Why the Credit Caution?

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Posted On: 10/08/2014

QUESTION:

We are in the process of buying a home and our lender has issued a strange and ominous warning: Do not use a credit card, do not open a new account, and do not make any big purchases. What gives?

ANSWER:

What your lender is looking for might be described as a “quiet period,” a few weeks of financial hermit-like living when credit use is held to a minimum between the time the purchase agreement was signed and closing actually takes place. The lender very much wants to protect your interests, and here’s why:

It used to be that when you applied for a mortgage the lender ran one credit check in an effort to find all of your monthly debts. This allowed the lender to figure out your required monthly payments for auto loans, student, credit card payments, etc. Once your credit was run the lender could determine your monthly payments and whether you had too much debt to qualify.

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Swing ahead to the new underwriting era – today – and the lending process is very different. Your lender is going to check your credit and figure your monthly payments just like in the old days. Then your lender is going to check again, maybe daily, and the lender will do this until closing.

The reason for the repeated credit checks is that the lender wants to get the loan right, and that means having a mortgage that meets certain standards. If the loan is wrong it’s possible that the lender will have to buy back the mortgage from an investor, not a cheap or happy prospect.

What the lender fears are undisclosed debts. Imagine that during the quiet period you go out and buy a new big-screen TV. The appliance store offers you 10 percent off if you will sign up for their new credit card. Sounds great, and in 60 seconds you have a new TV and a new credit card.

You may not see it as a big deal, but the new debt increases your required monthly payments. For marginal borrowers this means you may increase your costs to point where they pass a given limit, say a 43-percent debt-to-income ratio. As a result your loan might be lost – and with it the home and maybe your deposit.

Is this a real problem? You bet.

“Almost one-fifth of all mortgage borrowers, including those with solid credit scores and debt-to-income ratios apply for at least one new trade line during this period,” said Equifax in a 2013 study. “Many borrowers simply don’t realize how this new ‘undisclosed debt’ impacts their ability to qualify for their mortgage.”

A mortgage application was once a static event, you handed in your paperwork, and that was about it. No more. With multiple credit reviews you can count on lenders to check and re-check paperwork right up until closing. In fact, in one case a lender called while my wife and I were riding home from a closing. The lender’s question? Was my wife still employed! Happily, the answer was yes.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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