Module 2: Credit Documents

Credit documents provide valuable insights into an individual's financial history, current financial standing, and their ability to meet loan obligations.

The primary objective of examining credit documents is to evaluate an applicant's creditworthiness, which involves analyzing their credit history, credit scores, and overall financial stability. Lenders need to assess whether borrowers have a satisfactory track record of repaying debts, managing credit responsibly, and maintaining a stable income to determine their ability to handle the financial commitment of a mortgage loan.

Credit Basics, Credit Bureaus & FICO Scores

Credit documents are records that provide information about an individual's credit history, financial behavior, and ability to manage debt. These documents are essential for lenders to evaluate an applicant's creditworthiness and make informed decisions regarding lending money, including mortgage loans.

The Role of Credit Bureaus:

Credit bureaus, also known as credit reporting agencies, play a significant role in the credit industry. The three major credit bureaus in the United States are Equifax, Experian, and TransUnion.

They are responsible for collecting and maintaining credit information on individuals and businesses. The primary role of credit bureaus is to compile credit reports based on data received from creditors, financial institutions, and other sources. Credit bureaus gather information on an individual's credit accounts, payment history, outstanding debts, public records, and inquiries.

Credit bureaus act as intermediaries, providing lenders with the necessary information to assess a borrower's credit risk.

FICO Scores:

FICO scores are credit scores developed by the Fair Isaac Corporation, hence the name FICO. These scores are widely used by lenders to assess creditworthiness and make lending decisions. FICO scores range from 300 to 850, with higher scores indicating lower credit risk, making borrowers more likely to be approved for loans and potentially receive more favorable terms, such as lower interest rates.

FICO scores are calculated based on various factors, including payment history, amounts owed, length of credit history, types of credit used, and new credit applications. The exact formula used to calculate FICO scores is proprietary, and each credit bureau may have its own slightly different version of the scoring model.

Lenders typically request FICO scores from one or more credit bureaus when assessing a borrower's creditworthiness.

Credit Reports & Mortgage-Only Reports

A credit report is a comprehensive record of an individual's credit history, compiled by credit bureaus. It contains detailed information about the person's financial behavior, credit accounts, payment history, outstanding debts, public records, and other relevant financial data.

Credit reports are generated by credit bureaus based on the information they receive from various sources, including creditors, lenders, financial institutions, and public records.

Credit reports typically include the following information:

• Personal Information: This section includes the individual's name, date of birth, Social Security number, current and previous addresses, and employment history.

• Credit Accounts: The credit accounts section provides details about the person's credit accounts, such as credit cards, loans, mortgages, and lines of credit. It includes information about the account balance, credit limit, payment history, and the date the account was opened or closed.

• Payment History: This section displays the individual's payment history for each credit account. It indicates whether payments were made on time, any late or missed payments, and any delinquencies or accounts sent to collections.

• Public Records: Public records, such as bankruptcies, tax liens, and judgments, are included in this section. These records can significantly impact a person's creditworthiness and may stay on the credit report for several years.

• Inquiries: The inquiries section lists the entities or individuals who have accessed the individual's credit report. There are two types of inquiries: hard inquiries and soft inquiries. Hard inquiries occur when a lender reviews the report in response to a credit application, while soft inquiries are typically initiated by the individual or for promotional purposes.

Mortgage-Only Reports:

In addition to the standard credit reports, there are specialized reports known as mortgage-only reports or mortgage credit reports. These reports are specifically tailored to meet the needs of mortgage lenders and focus on the applicant's credit history as it relates to mortgage-related transactions.

Mortgage-only reports contain similar information as standard credit reports but emphasize aspects that are most relevant to the mortgage lending process. They provide a more detailed analysis of a borrower's mortgage-related payment history, mortgage accounts, and any past or current mortgage delinquencies.

Hard Pulls & Soft Pulls

It is important to understand the distinction between hard pulls and soft pulls of credit. These terms refer to different types of inquiries made on a borrower's credit report. Let's explore each type in detail:

Hard Pulls:

A hard pull, also known as a hard inquiry, occurs when a lender or creditor accesses an individual's credit report with the purpose of evaluating their creditworthiness for a new loan or credit application. Hard pulls typically happen when a borrower applies for a mortgage, auto loan, credit card, or any other type of credit that requires a thorough assessment of their credit history.

Key characteristics of hard pulls include:

• Impact on Credit Score: Hard pulls can temporarily lower a borrower's credit score. Each hard pull may deduct a few points from the score, though the impact is generally small and short-lived. Multiple hard inquiries within a short period can have a more significant impact on the credit score.

• Authorization Required: Hard pulls require the borrower's explicit consent. They are initiated when the borrower submits a credit application and grants permission to the lender or creditor to access their credit report.

• Recorded on Credit Report: Hard pulls are recorded on the borrower's credit report and remain visible to other lenders or creditors who review the report. They provide a record of the borrower's recent credit-seeking activity.

• Intention to Obtain Credit: Hard pulls are associated with the intent to obtain new credit. They indicate that the borrower is actively pursuing a loan or credit account and allow lenders to assess the borrower's creditworthiness more thoroughly.

Soft Pulls:

A soft pull, also known as a soft inquiry, occurs when an individual or an entity accesses their own credit report or when a lender reviews a borrower's credit for monitoring purposes or prequalification offers. Soft pulls do not impact a borrower's credit score and are typically used for informational or promotional purposes.

Key characteristics of soft pulls include:

• No Impact on Credit Score: Soft pulls do not affect a borrower's credit score. They are considered as a review or informational inquiry that does not involve a credit application or an intention to obtain new credit.

• No Authorization Required: Borrowers do not need to provide explicit consent for soft pulls. Credit bureaus may allow individuals, employers, or existing lenders to access credit reports for verification or monitoring purposes without the borrower's authorization.

• Not Recorded on Credit Report: Soft pulls are not recorded on the borrower's credit report. They are invisible to other lenders or creditors who review the report and have no impact on the borrower's creditworthiness assessment.

• Informational or Promotional Purposes: Soft pulls are commonly used for background checks, employment verification, insurance quotes, prequalification offers, and personal credit monitoring. They provide a snapshot of the borrower's credit profile without the intent of granting new credit.

It's important to note that while hard pulls can have a temporary impact on credit scores, the credit scoring models are designed to account for rate shopping within a certain timeframe. Multiple hard inquiries made within a specific period (such as 14 to 45 days, depending on the credit scoring model) for the same type of credit are generally treated as a single inquiry to minimize the impact on the borrower's credit score.

LQIs & Credit Rescores

In the context of intermediate mortgage lending, LQIs (Loan Quality Initiatives) and credit rescores are two important aspects to consider.

Loan Quality Initiatives (LQIs) are measures and guidelines implemented by mortgage lenders to enhance loan quality, mitigate risk, and comply with regulatory requirements. Credit rescores involve the process of requesting an update or correction to a borrower's credit report to reflect more accurate credit information. Understanding LQIs and credit rescores is essential in the intermediate mortgage lending process to ensure compliance, accuracy, and fair assessment of borrower creditworthiness.

Let's explore each of them in detail:

Loan Quality Initiatives (LQIs):

Loan Quality Initiatives are measures and guidelines implemented by mortgage lenders and loan originators to ensure the accuracy and integrity of loan applications, documentation, and underwriting processes. LQIs aim to enhance loan quality, reduce fraud, and mitigate risk within the mortgage lending industry.

Key characteristics of Loan Quality Initiatives include:

• Enhanced Verification Processes: LQIs require lenders to implement more rigorous verification processes to ensure the accuracy of borrower information and supporting documentation. This includes verifying income, employment, assets, and other key details provided by the borrower during the mortgage application process.

• Compliance with Regulations: LQIs ensure that lenders adhere to regulatory requirements, such as those outlined by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. Compliance with these guidelines is crucial to ensure the saleability of loans in the secondary market.

• Fraud Prevention Measures: LQIs include measures aimed at detecting and preventing mortgage fraud. Lenders are required to implement robust fraud prevention practices, such as thorough identity verification, anti-fraud training for staff, and utilizing fraud detection tools and technologies.

• Quality Control Procedures: LQIs necessitate the establishment of internal quality control procedures by lenders to monitor and evaluate loan origination processes. These procedures help identify and rectify any deficiencies or errors in loan documentation, underwriting decisions, and compliance with lending guidelines.

Credit Rescores:

Credit rescores refer to the process of requesting an update or correction to a borrower's credit report in order to reflect more accurate and up-to-date credit information. Credit rescores are typically initiated when there are errors or discrepancies in the credit report that may impact the borrower's creditworthiness assessment.

Key characteristics of credit rescores include:

• Dispute Resolution: Credit rescores often arise as a result of disputes initiated by borrowers or lenders regarding inaccuracies or inconsistencies in the credit report. Disputes may involve incorrect account information, inaccurate payment history, or other errors that negatively impact the borrower's creditworthiness.

• Credit Bureau Investigation: When a credit rescore is requested, the credit bureaus investigate the disputed information by reviewing supporting documentation and contacting relevant creditors or lenders. The goal is to determine the accuracy of the disputed items and update the credit report accordingly.

• Timeframe and Impact: Credit rescores can take varying amounts of time, typically ranging from a few weeks to a couple of months, depending on the complexity of the dispute. Once the credit report is updated, the borrower's credit score may be recalculated, potentially leading to improvements in creditworthiness if the inaccuracies are corrected.

• Reassessment of Creditworthiness: Credit rescores are particularly important in the mortgage lending process, as they can potentially impact a borrower's eligibility for a mortgage loan, loan terms, or interest rates. Correcting errors or inaccuracies through a credit rescore can result in a more accurate representation of the borrower's creditworthiness.

Liens & Judgments

In general, liens are legal claims placed on a property to secure the payment of a debt, while judgments are court orders confirming the debtor's legal obligation to repay a debt. Understanding liens and judgments is essential in the intermediate mortgage lending process to assess property ownership, prioritize claims, and evaluate the creditworthiness of borrowers. Let's explore each concept in detail:

Liens:

A lien is a legal claim or encumbrance placed on a property or asset to secure the payment of a debt or obligation. It serves as a form of collateral, giving the creditor the right to satisfy the debt by seizing or selling the property if the debtor fails to meet their payment obligations.

Key characteristics of liens include:

• Types of Liens: There are different types of liens that can be placed on a property. Common examples include mortgage liens, where a lender has a claim on the property as collateral for a mortgage loan, and tax liens, which are imposed by the government for unpaid taxes.

• Priority of Liens: Liens can have different priorities depending on when they were recorded or filed. The priority determines the order in which liens are satisfied if the property is sold or if there are insufficient funds to repay all creditors. Generally, liens are prioritized based on the date of recording or filing, with earlier liens taking precedence over later ones.

• Impact on Mortgage Lending: In the mortgage lending process, liens play a crucial role in determining the eligibility and loan terms for borrowers. Mortgage lenders typically conduct a thorough lien search to identify any existing liens on the property. The lender will ensure that their mortgage lien will have a superior position to other liens, providing them with the primary claim in case of foreclosure or default.

Judgments:

A judgment is a court order that confirms the legal obligation of a debtor to repay a debt owed to a creditor. Judgments are typically obtained through a lawsuit or legal proceedings initiated by the creditor to recover outstanding amounts.

Key characteristics of judgments include:

• Legal Validation: Judgments are obtained through a legal process where the creditor files a lawsuit against the debtor. If the court determines that the debt is valid and owed, it issues a judgment in favor of the creditor, requiring the debtor to pay the owed amount.

• Public Record: Judgments become public records and are typically recorded in the county or jurisdiction where the lawsuit was filed. As public records, judgments can be accessed by credit bureaus and other interested parties, including mortgage lenders, during the underwriting process.

• Impact on Mortgage Lending: Judgments indicate a history of debt default and legal action, which may raise concerns for lenders. Mortgage lenders typically consider judgments as outstanding debts that need to be repaid and may affect the borrower's debt-to-income ratio and overall creditworthiness.

It's important to note that liens and judgments can have serious implications for borrowers in the mortgage lending process. Mortgage lenders conduct thorough checks to identify any existing liens or judgments on the property and assess the associated risks. Borrowers are generally required to address outstanding liens and judgments or provide sufficient documentation to demonstrate that they have been resolved or paid off before obtaining a mortgage loan.

Consumer Explanation Letter

A consumer explanation letter, also known as a letter of explanation or LOX, is a document that borrowers may be required to provide to explain certain aspects of their financial history or circumstances. The purpose of a consumer explanation letter is to provide additional context or clarification to the mortgage lender regarding specific items or events that may impact the borrower's creditworthiness or loan application.

Key characteristics of a consumer explanation letter include:

• Providing Context: Consumer explanation letters are typically used when there are unusual or potentially concerning items in the borrower's financial history, such as gaps in employment, late payments, a high level of debt, or other credit-related issues. The letter allows borrowers to provide an explanation and context for these circumstances.

• Supporting Documentation: In addition to the letter itself, borrowers may be required to submit supporting documentation that substantiates their explanation. For example, if the letter addresses a period of unemployment, the borrower may include documentation such as termination letters, severance agreements, or evidence of job search efforts.

• Personalized and Detailed: Consumer explanation letters should be personalized, honest, and detailed. Borrowers should clearly explain the circumstances, dates, and any relevant information related to the item being addressed. The letter should aim to reassure the lender that any negative or concerning items in the borrower's financial history are isolated incidents or have been resolved.

• Addressing Specific Items: Consumer explanation letters should specifically address the items or events that require an explanation. For example, if there was a period of late payments on a credit card, the letter should detail the reasons behind the late payments and provide evidence of steps taken to rectify the situation and ensure timely payments moving forward.

• Lender's Requirements: The specific requirements for a consumer explanation letter may vary between lenders. Some lenders may provide a template or specific instructions on how they want the letter to be structured and what information should be included. It's important for borrowers to follow the lender's guidelines to ensure compliance and a smooth application process.

Consumer explanation letters can help borrowers address potential concerns or provide necessary context to lenders during the mortgage application process. By providing an explanation and supporting documentation, borrowers can potentially mitigate any negative impact that certain items in their financial history may have on their creditworthiness assessment.

Credit Supplements

A credit supplement is a report that is ordered by a mortgage lender to verify information on a borrower's credit report. It can be used to confirm the borrower's payment history, current balances, and any new accounts that have been opened since the original credit report was pulled.

Credit supplements are typically ordered when there are any discrepancies on the borrower's credit report, or when the lender needs to verify recent changes to the borrower's financial situation. For example, if the borrower has recently paid off a large debt, or if they have opened a new credit card, the lender may order a credit supplement to confirm these changes.

Credit Payoffs

A credit payoff refers to the process of repaying an outstanding debt in full, typically prior to or during the mortgage application process. Paying off credit accounts can have an impact on a borrower's credit profile and may influence their eligibility for a mortgage loan and the terms they can obtain.

Here are some important points to understand about credit payoffs:

• Purpose: The purpose of a credit payoff is to eliminate or reduce outstanding debt obligations. By paying off credit accounts, borrowers aim to improve their creditworthiness, reduce their debt-to-income ratio, and demonstrate financial responsibility to potential mortgage lenders.

• Types of Credit Accounts: Credit payoffs can involve various types of credit accounts, such as credit cards, personal loans, student loans, auto loans, or other lines of credit. The specific accounts that borrowers choose to pay off will depend on their financial situation, debt priorities, and advice from their mortgage lender or financial advisor.

• Impact on Credit Scores: Paying off credit accounts can have both positive and negative impacts on credit scores. On one hand, it can improve credit utilization ratios and demonstrate responsible debt management, potentially boosting credit scores. On the other hand, closing accounts can reduce the length of credit history and decrease the available credit, which may have a temporary negative impact. However, the overall effect on credit scores will vary based on individual circumstances.

• Credit Utilization Ratio: Credit payoffs can also positively affect a borrower's credit utilization ratio. This ratio compares the amount of credit used to the total available credit. By paying off credit accounts, borrowers reduce their credit utilization, which can improve their credit scores and demonstrate responsible credit management.

• Debt-to-Income Ratio: Paying off credit accounts can positively impact a borrower's debt-to-income (DTI) ratio, which is an important factor considered by mortgage lenders during the loan approval process. By reducing outstanding debt, borrowers can lower their DTI ratio, making them more attractive to lenders and potentially increasing their borrowing power.

• Timing Considerations: Borrowers should consider the timing of credit payoffs in relation to their mortgage application. Paying off credit accounts too close to the loan application may not allow enough time for the credit bureaus to update the information, potentially delaying the mortgage approval process. It's advisable to discuss the timing of credit payoffs with the mortgage lender to ensure a smooth application process.

• Lender's Requirements: Each mortgage lender may have specific requirements or guidelines regarding credit payoffs. Some lenders may require borrowers to pay off certain types of debts or meet specific criteria before approving a mortgage loan. It's important for borrowers to communicate with their lender and understand their specific requirements and recommendations for credit payoffs.

Fraud Freezes

A fraud freeze, also known as a credit freeze, is a security measure that individuals can take to protect themselves against potential identity theft and fraudulent activities. A fraud freeze allows individuals to restrict access to their credit reports, making it difficult for unauthorized parties to open new credit accounts or loans in their name.

Here are some key details about fraud freezes:

• Purpose: The primary purpose of a fraud freeze is to prevent identity thieves from accessing an individual's credit information and using it to open fraudulent accounts or loans. By placing a freeze on their credit, individuals add an extra layer of protection against unauthorized credit inquiries and applications.

• Freezing Credit Reports: When an individual requests a fraud freeze, the credit reporting agencies (Equifax, Experian, and TransUnion) are notified to restrict access to their credit reports. This means that potential lenders or creditors cannot view the credit information unless the freeze is lifted or temporarily lifted by the individual.

• Process and Requirements: To initiate a fraud freeze, individuals typically need to contact each of the three credit reporting agencies individually and follow their specific procedures for requesting a freeze. This may involve submitting certain personal identification information and paying a fee, although some jurisdictions provide free credit freezes.

• Impact on Credit Access: While a fraud freeze provides security against identity theft, it also restricts legitimate access to credit reports. When a freeze is in place, creditors or lenders cannot easily check an individual's credit history to approve credit applications. Therefore, individuals must be prepared to lift or temporarily lift the freeze when applying for credit, such as a mortgage loan, to allow the lender to review their credit information.

• Temporary Lifts or Thaws: Credit freezes can be temporarily lifted or thawed to allow access to credit reports for specific periods or for specific creditors. This can be done by contacting the credit reporting agencies and providing the necessary information to authorize the temporary lift. After the authorized period, the freeze is automatically reinstated.

• Impact on Mortgage Lending: When applying for a mortgage loan, individuals may need to temporarily lift the fraud freeze to allow the lender to review their credit history and determine their creditworthiness.

It's important to note that the specific procedures, fees, and regulations regarding fraud freezes may vary by jurisdiction.

Divorce Decrees: Court Ordered & Voluntary Agreements

Divorce decrees play a role in the mortgage application process when the borrowers have gone through a divorce or are in the process of getting divorced. Divorce decrees are legal documents issued by a court that outline the terms of a divorce settlement, including the division of assets, liabilities, and responsibilities between the former spouses. There are two main types of divorce decrees: court-ordered and voluntary agreements.

Court-Ordered Divorce Decrees:

A court-ordered divorce decree is issued by a judge after the divorce proceedings. It is a legally binding document that specifies the terms of the divorce settlement based on the judge's determination of a fair and equitable division of assets, liabilities, and responsibilities. The court may consider factors such as marital property, child custody and support, spousal support (alimony), and debt allocation.

In the case of a court-ordered divorce decree, the terms outlined in the document must be followed by the parties involved. Lenders will typically require a copy of the divorce decree to verify the agreed-upon terms and to determine the borrower's financial obligations.

Voluntary Agreements:

A voluntary agreement, also known as a separation agreement or marital settlement agreement, is a legal document that outlines the terms of the divorce settlement agreed upon by the divorcing spouses. Unlike a court-ordered divorce decree, a voluntary agreement is negotiated and agreed upon by the parties involved without the intervention of a judge.

Lenders typically require a copy of the voluntary agreement to ensure compliance with the agreed-upon terms and assess the borrower's financial obligations.

Key Considerations:

It's important to note that mortgage lenders have their own requirements and guidelines when it comes to considering divorce decrees or voluntary agreements. Here are some key considerations:

• Validity and Enforceability: Lenders will review divorce decrees or voluntary agreements to ensure they are valid, legally binding, and enforceable. They may request proof that the document was properly executed and filed with the court.

• Payment Responsibility: Lenders will determine the responsibility for mortgage payments based on the divorce decree or voluntary agreement. This includes assessing the income, creditworthiness, and financial obligations of each spouse individually.

• Property Ownership: If the divorce decree or voluntary agreement involves the transfer of property ownership, lenders may require additional documentation, such as a quitclaim deed, to verify the transfer and the borrower's legal ownership of the property.

• Documentation: Borrowers will typically need to provide a copy of the divorce decree or voluntary agreement as part of the mortgage application process.

Bankruptcy, Foreclosure, Short Sales & Deed-in-Lieu

In the context of mortgage lending, bankruptcy, foreclosure, short sales, and deed-in-lieu are important concepts related to financial hardships and potential resolutions for homeowners who are unable to meet their mortgage obligations. Here's an overview of each:

Bankruptcy:

Bankruptcy is a legal process in which individuals or businesses declare their inability to repay their debts. Bankruptcy can be filed under different chapters of the U.S. Bankruptcy Code, with Chapter 7 and Chapter 13 being the most common for individuals.

• Chapter 7 Bankruptcy: Also known as liquidation bankruptcy, Chapter 7 involves the sale of non-exempt assets to repay creditors. It typically results in the discharge of most unsecured debts, but it may not prevent the foreclosure of a property if mortgage payments are not made.

• Chapter 13 Bankruptcy: Chapter 13 involves the creation of a repayment plan to pay off debts over a period of three to five years. It allows homeowners to catch up on missed mortgage payments and potentially avoid foreclosure by restructuring their debts.

Bankruptcy can have significant implications for mortgage lending. It may affect a borrower's ability to qualify for a mortgage loan, and the specific waiting periods and requirements vary depending on the type of bankruptcy and the loan program. Borrowers who have gone through bankruptcy will typically need to reestablish their creditworthiness and meet specific criteria set by lenders.

Foreclosure:

Foreclosure is a legal process initiated by a lender when a borrower fails to make mortgage payments as agreed. It involves the lender reclaiming and selling the property to recover the outstanding loan balance. Foreclosure processes and timelines vary by jurisdiction, but typically involve a series of steps, including default notice, public auction, and eviction if necessary.

Foreclosure has a significant impact on a borrower's credit and ability to obtain a mortgage loan. It stays on the credit report for several years and can severely affect credit scores. Borrowers who have experienced foreclosure will generally face challenges in obtaining new mortgage financing and may need to wait for a specific period and demonstrate improved creditworthiness.

Short Sales:

A short sale occurs when a homeowner sells their property for less than the outstanding mortgage balance, with the lender's approval. It is typically an option pursued by borrowers who are facing financial difficulties and cannot afford to continue making mortgage payments.

In a short sale, the homeowner must demonstrate financial hardship to the lender and obtain their consent to sell the property below the loan balance. The sale proceeds are used to partially satisfy the debt, and the lender typically forgives the remaining amount owed.

Short sales can have less severe credit implications compared to foreclosure, but they still negatively impact credit scores. Borrowers who have completed a short sale may need to reestablish their credit and meet specific waiting periods and requirements before qualifying for a new mortgage loan.

Deed-in-Lieu:

A deed-in-lieu of foreclosure is a voluntary agreement between a homeowner and the lender where the homeowner transfers ownership of the property to the lender to satisfy the mortgage debt. It is an alternative to foreclosure.

In a deed-in-lieu, the homeowner voluntarily transfers the property title to the lender, and the lender typically forgives the remaining debt. The homeowner avoids foreclosure, and the lender gains ownership of the property.

Deed-in-lieu transactions can have similar credit implications to foreclosure or a short sale, with negative impacts on credit scores. Borrowers who have undergone a deed-in-lieu may need to rebuild their credit and meet specific waiting periods and requirements before being eligible for a new mortgage loan.

It's important to note that the specific mortgage lending requirements and waiting periods following bankruptcy, foreclosure, short sales, or deed-in-lieu can vary depending on the loan program, lender, and individual circumstances.

In summary, bankruptcy, foreclosure, short sales, and deed-in-lieu are different paths that homeowners may encounter when facing financial difficulties and challenges in meeting their mortgage obligations. Each has specific processes, implications for credit, and requirements for obtaining new mortgage financing.