Homebuyers make a lot of mistakes that hurt their chances of getting a mortgage preapproval from their lender. You don't want to join their ranks and sabotage your home purchase.
To find out what those missteps are, we talked to two lending experts: Casey Fleming, a mortgage advisor with C2 Financial Corp. in San Jose, California, and Heather McRae, a senior loan officer with Chicago Financial Services in Chicago.
Here are the six common mistakes they see borrowers make — and tips to avoid them:
1. Closing credit accounts
Once you’ve paid off a credit card or revolving debt account, you might be tempted to close the account so you don’t run it up again. But doing so actually hurts your credit, Fleming cautions. In order to get a mortgage preapproval, you'll need at least two current lines of traditional credit with at least a two-year payment history; the longer you've had them the better, Fleming says. Check with a mortgage broker to find out how much your score would be affected by closing paid-off credit accounts before you make any decisions.
2. Paying down only high-interest credit cards
Although this is the right approach most of the time, it actually helps more to pay down balances that make up a higher percentage of your available credit, a situation known as a higher credit utilization ratio. When the credit utilization ratio reaches more than 50%, it can damage your chances of getting a mortgage preapproval, McRae says. For example, if you have a credit card with a $10,000 limit and the balance exceeds $5,000, your credit score is hit pretty hard, she says. Although it's generally best to have a credit utilization ratio below 30%, if you have high utilization across several credit cards, paying those accounts down at least below 50% can dramatically help your chances of earning your lender's stamp of approval.
3. Taking out major loans
This one seems like a no-brainer, but both McRae and Fleming say they see many borrowers make this mistake. Don’t be one of them. Avoid taking out large car or student loans until after your home purchase closes. Otherwise, your debt-to-income ratio will be higher — and your chances of getting a mortgage will be lower — because you’re adding new debt to your plate while your income stays the same, Fleming says.
4. Paying off old debts you don't need to repay
If you have debts that have been in collections for several years, you may not have to pay them off. It’s possible, depending on your state’s statute of limitations, that the debt is no longer collectible and won’t affect your credit score, Fleming says. Generally, states impose a limit of three to six years for collection agencies to collect debts, but the law varies from state to state, so you might want to check with an attorney to see if you have old debts you must repay.
5. Changing from salary to commission
Mortgage lenders typically require a two-year history of commissions or self-employment income for a mortgage preapproval. If your income is 25% or more based on commission earnings, that means you must have documented proof over two years for loan preapproval, McRae says.
6. Waiting to cash in investments
Generally, you need to have at least three months' worth of cash reserves available in order to show the lender you can continue making monthly mortgage payments if you lose your income unexpectedly. Securities such as stocks, mutual funds and other investments are counted as part of your asset reserves for mortgage underwriting purposes. Typically, though, cash assets need to be in hand for two or three months, depending on the lender, to be counted. The value of securities fluctuates, and it costs money to sell and convert those investments into cash, which is why mortgage underwriters consider them to be worth only 65% to 75% of their actual value when evaluating your creditworthiness, Fleming says.
"Because we're not counting securities at full value, a borrower can appear short on cash reserves even though they have plenty of money," Fleming says. "As a result, we can't get preapproval for the mortgage loan." If you need to beef up your cash reserves, sell your securities before you seek preapproval so the lender will consider their full value — less any costs you incurred selling them — Fleming says.
Next steps for mortgage preapproval
If buying a home is on the horizon, it’s worth sitting down with a mortgage professional now to learn how you can more easily get preapproved for a mortgage when you are ready to buy.