How Do Lenders Consider Negative Credit Flags?
A prior post regarding the most significant credit events included foreclosures, pre-foreclosures, deed-in-lieu, and bankruptcies as negative credit flags. These significant credit events keep the primary mortgage buyers (Fannie Mae and Freddie Mac) from purchasing a mortgage loan from an affected borrower. These events also preclude guarantees by federal agencies (FHA, VA, USDA). Private entities likely follow the timelines from the events closely. As a result, impacted borrowers have few, if any, alternatives. However, there may exist some lenders offering high rates for these riskiest of the risky borrowers. But this site doesn’t provide guidance where these lenders can be found. The vast majority of possible home owners taking on such a risky loan will actually not be helped.
Lesser Negative Credit Events
What about other, less impactful, negative items on credit reports? Fannie Mae and Freddie Mac tend to drive the market for consideration of negative credit items, However, private lenders such as banks and credit unions which sell few or no loans, may vary substantially in how they evaluate less significant credit events. Private lenders which do not sell loans into Fannie and Freddie may be more flexible. For any borrower, a pattern of negative credit events not only impacts credit scores, but also limits options with any lender. This post focuses on Fannie Mae as the largest lender. But one may interchange Fannie Mae and Freddie Mac as having very similar, if not identical, criteria and views on derogatory and negative credit items.
Credit Bureau Reporting
Credit bureaus such as Transunion, Experian and Equifax reflect the information provided to them. Read Winning Mortgage, Winning Home for more information on managing credit items and avoiding credit cleanup scams. Each entity that reports payments from a borrower reports it by Tradeline. Have a car loan – a tradeline. Use a department store card – a tradeline. Have a general credit card – a tradeline. Took out a student loan – a trade line.
These samples of tradelines don’t reflect every possible type of borrowing. It provides some flavor as to what a lender must review. These tradelines have a variety of statuses. CURRENT reflects a good status. Paid As Agreed may or may not be negative. Many other statuses can show up – Late 30 or Late 60 (negative but not lethal). Payments late 90, 120, or 150 days have greater negative impact. Default, Collection, Judgment/Charge-Off and others brutally affect a credit score. The list shows increasing order of negative effect on your credit. How does forbearance play in to the credit score?
A borrower can be affected by other items not connected to the borrower’s tradeline. A borrower may be able to sign on someone else’s credit card -termed an authorized user. Negative credit by the other party can affect the borrower’s likelihood of loan approval. Authorized use under a spouse’s tradeline may have limited effect. Many borrowers apply without a spouse on the application. With sufficient income by the person applying, a spouse’s poor credit has no effect. A borrower will need to document the relationship of the owner of the tradeline and the borrower. To do so, Fannie Mae notes various steps and tests in its approval requirements.
Authorized User Tradelines
Fannie Mae’s automated underwriting system takes credit report tradelines designated as authorized user tradelines into consideration in automated underwriting. Since negative credit flags of someone not the borrower can also affect mortgage loan approval, additional investigation occurs for these tradelines. However, the lender must review where the applicant has been designated as an authorized user to ensure the tradelines accurately reflect the borrower’s credit history. A lender may believe the authorized user tradelines don’t accurately reflect the borrower’s credit history. In this case, the lender has some leeway to use prudent underwriting judgment when making its final underwriting decision.
The lender reviews whether the borrower has several authorized user accounts but only has a few accounts of his/her own. If so, the lender should establish:
- the relationship of the borrower to the owner of the account,
- if the borrower uses the account, and
- if the borrower makes the payments on the account.
Tradeline Verification
If the authorized user tradeline belongs to another borrower on the mortgage loan, the lender can omit additional investigation. But when the borrower has several tradelines in good standing and only a minor number of authorized user accounts, the lender could make the determination that:
- the authorized user accounts had minimal, if any, impact on the borrower’s overall credit profile; and
- the information reported on the credit report accurately reflects of the borrower’s credit history.
As noted, the lender is not required to review an authorized user tradelines that belongs to the borrower’s spouse when the spouse is not on the mortgage transaction.
Tradeline Disputes
Disputing a tradeline may have no effect. Fannie Mae notes if the credit report contains tradelines disputed by the borrower. When this occurs, its automated underwriting system will first assess the risk of the loan casefile using all tradelines, including those disputed. If Fannie Mae’s automated underwriting system issues an Approve recommendation using the disputed tradelines, the loan can be approved. Lack of an Approve flag requires the underwriting be re-run without the disputed accounts.
If the loan receives an Approve without the disputed items, the lender will need to take significant time to investigate the negative credit flags. The borrower must provide sufficient written proof about the validity of the dispute. The lender may decide the proof isn’t sufficient. Perhaps further evidence can provide that proof? That evidence will be required before the account reported may be accurate and the loan sold to Fannie Mae. So, paying a company to dispute items at credit bureaus likely will be a waste of money. Read more about this in Winning Mortgage, Winning Home.
Fannie Mae’s automated underwriting system also compares balances and payments to calculate the DTI. Read more in Winning Mortgage, Winning Home about DTI and tips to present this in the best light for a loan approval.
This list of the most relevant issues reflects only part of the underwriting process. Negative credit flags pose just one underwriting issue. Many, many other considerations influence the underwriting and approval process.