Chapter 8: Credit Analysis


Overview

Credit analysis is a critical component of mortgage underwriting. It evaluates the borrower’s creditworthiness and financial responsibility through their credit history, scores, payment patterns, and liabilities. This chapter provides a detailed understanding of credit reports, evaluation procedures, credit scoring models, and underwriting guidelines used to determine borrower risk.

Section 1: Purpose of Credit Review

1.1 Why Credit is Reviewed

  • To determine borrower’s ability and willingness to repay debt.
  • To assess the borrower’s financial behavior over time.
  • To uncover any major derogatory events (bankruptcy, foreclosure).
  • To calculate debt-to-income (DTI) ratios.
  • To confirm liabilities and minimum monthly payments.

Section 2: Understanding the Credit Report

2.1 Components of a Credit Report

  • Borrower Identifying Information
    • Name, Social Security number, date of birth, addresses
  • Credit Scores
    • FICO or VantageScore models used
  • Trade Lines
    • Account type, creditor, balances, payments, status
  • Inquiries
    • Hard inquiries in the last 90–120 days
  • Public Records
    • Bankruptcy, foreclosure, liens, judgments
  • Collections
    • Unpaid accounts turned over to collections

2.2 Credit Report Sources

  • Credit reports are pulled from:
    • Equifax
    • Experian
    • TransUnion
  • Tri-merge credit report (combined from all 3) is standard

Section 3: Credit Scores

3.1 FICO Scoring Model

  • Score range: 300–850
  • Key Factors:
    • Payment history (35%)
    • Credit utilization (30%)
    • Length of credit history (15%)
    • New credit (10%)
    • Credit mix (10%)

3.2 Score Thresholds

  • Excellent: 740+
  • Good: 700–739
  • Fair: 640–699
  • Poor: < 640

3.3 Minimum Score Requirements (Examples)

  • Conventional Loans (FNMA/FHLMC): 620+
  • FHA Loans: 580+ (lower with overlays)
  • VA Loans: No minimum, but lenders require ~620
  • USDA Loans: 640+
  • Non-QM/Jumbo: Varies by lender

Section 4: Derogatory Credit Events

4.1 Late Payments

  • 30-day, 60-day, 90-day lates
  • Recent late payments (last 12 months) are scrutinized
  • Housing-related lates (mortgage/rent) are most critical

4.2 Collections and Charge-Offs

  • Medical collections often excluded
  • Non-medical collections may need to be paid off depending on loan program
  • Charge-offs usually don’t require payoff unless recent

4.3 Judgments and Liens

  • Must be paid off before or at closing
  • Payment plans require documentation and payment history

4.4 Bankruptcy

  • Chapter 7: 2 years post-discharge (FHA), 4 years (Conventional)
  • Chapter 13: 1 year into payment plan with court approval (FHA), 2 years post-discharge (Conventional)

4.5 Foreclosure and Deed-in-Lieu

  • Waiting periods:
    • Conventional: 7 years (Foreclosure), 4 years (Deed-in-lieu)
    • FHA: 3 years
    • VA: 2 years

Section 5: Evaluating Liabilities

5.1 Installment Loans

  • Must be included in DTI
  • Remaining payments < 10 months may be excluded in some cases

5.2 Revolving Accounts (Credit Cards)

  • Use monthly minimum payments shown on credit
  • If no payment listed, use 5% of balance or actual statement

5.3 Student Loans

  • Conventional: Use actual payment or 1%/0.5% depending on type
  • FHA: Use 0.5% of balance if no payment shown
  • VA: May exclude if deferred >12 months

5.4 Auto Leases

  • Always included, regardless of months remaining

5.5 Authorized User Accounts

  • May be excluded if:
    • Borrower is not responsible
    • Primary user has good history and low balance

Section 6: Mortgage-Related Credit

6.1 Mortgage History

  • Housing payment history (mortgage/rent) is key
  • Verified through:
    • Credit report
    • VOR (Verification of Rent)
    • Cancelled checks or bank statements

6.2 Multiple Properties

  • Confirm if borrower owns other financed homes
  • Include full mortgage payments for all properties
  • Check for homeowners association dues (HOA)

Section 7: Inquiries and New Debt

7.1 Credit Inquiries

  • Inquiries in last 90 days must be explained
  • Lenders check for new undisclosed debt
  • May require:
    • Borrower letter of explanation
    • Credit supplement or account statements

7.2 New Debt Before Closing

  • Trigger alerts via Undisclosed Debt Monitoring (UDM)
  • Must be included in DTI if new accounts are opened
  • Final credit report may be pulled before funding

Section 8: Manual vs. Automated Underwriting

8.1 Automated Underwriting Systems (AUS)

  • DU (Desktop Underwriter – Fannie Mae)
  • LP (Loan Product Advisor – Freddie Mac)
  • AUS evaluates:
    • Credit score
    • Credit depth
    • Derogatory items
    • Payment history
  • May approve even with blemishes based on overall risk

8.2 Manual Underwriting

  • Used if AUS “Refer” or for specific programs
  • Requires:
    • Strong compensating factors
    • Clean housing history
    • Low DTI
    • Stable income
  • More conservative on credit

Section 9: Credit Supplements and Corrections

9.1 Credit Supplements

  • Used to verify or update tradeline details:
    • Balances
    • Payment amounts
    • Status
  • Obtained through credit vendor (with borrower authorization)

9.2 Disputed Accounts

  • Disputed tradelines can inflate scores
  • May require removal from report
  • Some loans require resolution before approval (especially FHA)

Section 10: Red Flags and Risk Indicators

10.1 Signs of Credit Risk

  • Multiple recent inquiries
  • Recent late payments
  • High utilization on revolving debt
  • Thin credit file (few tradelines)
  • Discrepancies in borrower declarations

10.2 Risk Mitigation Strategies

  • Request letters of explanation (LOE)
  • Require reserves as compensating factor
  • Use non-traditional credit when needed
  • Consider co-borrower or additional income

Section 11: Case Studies

Case 1: Thin Credit File

  • Borrower with 1 auto loan and 1 credit card
  • Added rental history and utility bills as non-traditional credit
  • Approved through manual underwriting

Case 2: Bankruptcy 3 Years Ago

  • Chapter 7 discharged 3 years prior
  • Clean history since discharge
  • AUS approved with compensating income/reserves

Case 3: High Revolving Debt

  • 3 credit cards with 90%+ utilization
  • Paid down to <30% before rescore
  • Score increased, eligible for loan program

Final Notes

  • Credit is not just a score; full report analysis is essential
  • Underwriters must review all aspects: payment history, depth, and behavior
  • Borrower explanation and documentation can offset marginal credit
  • Conservative judgment and investor overlays must guide the decision

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