How Surprise Undisclosed Debt Can Sink Your Mortgage Application
Most people work very hard to be in a position to obtain a mortgage, and yet in a surprising number of cases loan applications fall through for the oddest reason: Borrowers are racking up new debt during the application process.
A new report from Equifax shows that almost 14 percent of all mortgage borrowers — one out of seven — apply for new debt at the same time they're seeking to finance or refinance a home.
"Many borrowers, says the Equifax study, Zooming in on Undisclosed Debt, "simply don't realize how this new 'undisclosed debt' impacts their ability to qualify for their mortgage."
In fact, new undisclosed debt can sink a mortgage application. It's that simple — and reason enough to never open a new credit account while applying for a mortgage.
So why are borrowers being denied loans because of new credit purchases?
When you apply for a mortgage, one of the first steps taken by a lender is to check your credit. Passing that first inspection doesn't put you in the clear, however — lenders routinely do another credit check just before closing. If that second check shows more debt and higher monthly costs, the entire application process can come to a halt. In fact, if that second credit report shows inquiries (which could indicate that you have applied for credit), your mortgage gets derailed. Here's why:
Let's imagine that you want an FHA loan which allows up to 31 percent of your income to be used for housing costs such as mortgage principal, interest, taxes and insurance. If your monthly household income is $7,000 per month before taxes it means you can afford $2,170 for housing costs.
In addition, say that you are allowed to use as much as 43 percent of your monthly income for all recurring costs, including housing expenses. For a household that earns $7,000 per month, the borrowers can support monthly bills for such things as housing, auto loans, student debt and credit card bills equal to $3,010.
If we subtract $2,170 from $3,010 it means $840 is available for recurring monthly payments in addition to housing expenses.
Next, imagine that a borrower goes to a store just before closing to buy a new bed. The cost is $1,599 — but you can save 10 percent if you put it on the store's credit card. The borrower opens a new account, what the lending industry calls a "trade line."
The new account shows up on the credit system. The numbers which allowed the borrower to qualify for a new mortgage now have to be re-done. If monthly debts are above $3,010 in this example there's a good chance the loan application will be declined or delayed. If delayed, it's possible that the lock period will expire and that financing will only be available at the current mortgage rate, a rate which could be higher than the original lock-in.
The Equifax analysis showed that "the average monthly payment of new undisclosed debt was $251 with an average of 1.2 trade lines per borrower. Therefore, a couple in a household averages 2.4 trade lines per mortgage."
There's another problem lurking here: As Equifax explains, if the borrower's hidden debts are three percent above the allowable limit the lender may be forced to repurchase the loan from Fannie Mae, Freddie Mac or others who buy such debt. The threat of repurchase demands is one major reason why lenders check and re-check credit — and why Equifax now has a new product which updates credit information for lenders on a daily basis.
No lender wants to repurchase a mortgage. It's expensive, problematic and explains in part why lenders today so-carefully examine mortgage applications.
Help yourself: Once you make a mortgage application, stay away from malls, online emporiums, auto dealers, furniture stores, electronics outlets and other places where you can make big credit purchases until well after your mortgage closes and your loan officer says new credit spending is okay.