My credit score isn't great - how is it going to impact my mortgage?

[Anonymous]

Hi all - I'm new to the board and also to knowledge of mortgages/credit/etc.  Thanks in advance for your insights.

My wife and I are currently looking to purchase a single family house on the north side of Chicago to serve as our primary residence.  We currently live in a 2 bed/2 bath condo also on the north side of Chicago (purchased in 2003, and conservatively valued at $265k), which we would ideally like to keep as an income property.

I’ve included a number of key details below to contextualize my questions.

Questions:

• How badly is my credit score going to hurt us in terms of qualifying for a mortgage and favorable interest rates?  Will an increase in my credit score of +25-40 points in the next 3-6 months make a significant difference?  Should we wait to begin the approval/purchase process until a certain period of time has passed?
• This is just a general question, but how do lenders determine a married couple’s risk in situations where one partner has excellent credit, but minimal income, and the other partner doesn’t have the best credit but has a more substantial income? 
• If it is possible to get an assessment, would we qualify to purchase a $325k house, or how about a $550k house?  Assuming in both cases that we don't sell our current condo
• If we purchase the house for $325k, there is a significant amount of renovation work that we’d like to do.  What would be the most effective way to purchase this property and pay for the renovations, i.e. go with a smaller down payment, and use savings, etc, to pay for renovations, or make a larger down payment and try to get a home equity loan
• Does the fact that this purchase may be for a 'second' home, change anything regarding credit/mortgage approvals?

Some Background:

Credit

My current credit score of 625, with some problems.  One unpaid (medical) collection reported 04/08, that I’m in the process of disputing, and that should not have been listed at all.  I don’t know how the collection will be perceived once the problem has been rectified, but the claim should never have been filed in the first place.  Unfortunately I do have a history of late payments.  My wife has very good credit, with a score of 750+. 

My late payment history:

CC Account 1:

Opened 11/00 – Current

Late payments: None

Outstanding balance: $4,000

 

CC Account 2:

Opened 10/93 – closed 9/08

Late payments: 8/08 (30), 3/08 (30), 1/06 (60), 12/05 (30)

 

CC Account 3:

Opened 1/99 – closed 10/08

Late payments: 05/02 (30)

 

CC Account 4:

Opened 4/04 – closed 9/08

Late payments: 7/04 (30)

 

CC Account 5:

Opened 11/07 – closed 3/08

Late payments: 2/08 (30)

Income/Employment

My annual income is $100,000 + 15-20% 2008 bonus.  I have been with the same employer for almost nine years.  My wife has just started her own business, and her 2008 annual income will be approximately $25k. 

Monthly Debt Payment

Our current mortgage is in my wife’s name, and is $1,350 including property taxes, with an additional $150/month in condo assessments.  We also have a student loan payment of $250/mo, and no car loans.  Monthly credit card minimum is $200, but have been paying off $2,000+ monthly. 

Assets / Reserves

We have $50,000 in savings, $2,000 in checking, plus ready access to another $15,000 in stock.  My 401k is worth approximately $70k currently.  I also have a company pension and profit sharing of comparable values that I don’t believe that I can access currently.  Additionally we do have offers of additional family assistance for a down payment, if necessary.

Thanks again!

[ShanetheMortgageMan]

Welcome to the forums.

First, out of curiousity, why did you recently close CC accounts #2-5?  Or were they closed by the creditor?  Reason I ask is if they were open and you continued to have on time payments afterwards, you would increase your chances of being able to remove the past late payments via writing a goodwill letter.

There are two layers to your situatoin -  credit & debt to income ratio.

If you have enough of a down payment your credit is probably fine now to qualify.  But if you can I would wait until the unpaid medical collection is removed from your credit report, since it was within the past 12 months, after removal, you should see a nice increase in the scores, and be able to qualify more easily with a lower down payment if you choose.  Your wife's credit is great, which is a reason that you might want to include her on the loan application.  It's so great that it would compensate for your not-so-great credit even with a small'ish down payment.

I imagine that buying the home would be considered some sort of "upgrade" for you, either in terms of sales price of square footage/accommodations.  If so, that solves the "second home" issue because it would be apparent it'll be your new primary residence.  If you are downgrading, then there should be a really good reason as often lenders tend to think borrowers are trying to scam them buy buying an investment property under more attractive owner occupied terms.

How much you can qualify for will depend on if your wife will be on the loan or not, if you can include rental income on the existing condo when qualifying for the new mortgage, and how much of a down payment you'd want to put down.

If you were going to qualify by yourself for the $550k home, could put down $133k to get the loan amount to the conforming limit of $417k, and had $15k in reserves after... then you would have a good shot at getting approved.  The reason I say that is because your wife's condo payment would not be included in qualifying since she wouldn't be on the loan, your debt to income ratio would still be a little bit high (assuming bonus income hasn't been received for 2 years, and thus couldn't be used), and your credit still just so-so, but you'd have 4 times your proposed housing payment in reserves and you'd be putting nearly 25% down so that solves a lot of other issues.

If you wanted to add your wife to the loan, then you would need to consider her condo & it's payment in the equation.  Lenders have recently changed guidelines when using rental income in the situation where someone owns a home, is buying a new home, and will be renting their current home out.  Before all you needed was a rental/lease agreement.  Now you need to have a certain amount of equity, either 25% if doing an FHA loan or 30% if doing a conventional loan, and you also need to get the security deposit/1st months rent put into your account.  So if you do not have the equity in the condo, then including your wife on the application would reduce the amount you could qualify for. 

Since your wife's self-employment is new then it probably won't be able to qualify.  Once she's been self-employed for 2 years will it qualify with no problem, between 1-2 years it'll qualify only if she's had a previous 2 year history being employed in the same field/line of work, less than 1 year it won't qualify at all.  So putting her own brings her condo & good credit in the equation, but probably not any income to offset the condo payment.

Now you mentioned $325k sales price twice, so I figure you were just throwing the $525k sales price out there for fun and you are probably leaning more towards buying a home for $325k.  So let's say your wife is on the loan, there is no qualifying rental income to help offset the condo payment in the debt ratio, and you are just putting 3% down.  Payment would be about $2,400/mo, so on an FHA loan your debt to income ratio would be 29% for the housing portion, which qualifies easily, but a little high at 52% for the total debt ratio which is above FHA's preferred level of 43%.  A total debt ratio above 43% can qualify if there are compensating factors.  One big compensating factor like I mentioned before is a down payment, so if 3% down is too much risk then you'd try 5% down, 10% down, etc.  A loan officer can run various scenarios through the loan approval system - called an automated underwriting system (a computer program designed to assess risk on mortgage transactions) - until your situation gets approved.  One thing they can't simulate is better credit though.  So if you are in no rush to buy, wait until the medical collection is removed from credit, then have your credit run & go for the approval.

Sheesh... your post is still longer than mine.

Message Edited by ShanetheMortgageMan on 11-17-2008 05:42 PM