Applying for a mortgage means the lender is going to look at every aspect of your financial life. This includes all aspects of your credit report, down to the credit inquiries. These are located at the bottom of your credit report and let lenders know if you have applied for any credit recently.
It might not seem like a big deal to you to have inquiries on your credit report. However, to a potential lender, they are a big deal.
When do Credit Inquiries Hit Your Credit Report?
Any time that you apply for new credit, you’ll see a credit inquiry on your credit report. If you fill out an application and actively apply for new credit, that lender will send a notification to the credit bureaus right away. This lets other lenders know that you are actively applying for credit with them.
If someone pulls your credit report for a reason other than actively obtaining new credit, it may be a ‘soft credit pull.’ This does not affect your credit score and is not reported as a credit inquiry. Employment checks, pulling your own credit or pre-approval offers are examples of soft credit pulls.
Why do Lenders Care?
Now, the bigger question is why would lenders care about the credit inquiries on your credit report. Isn’t it your business if you applied for credit elsewhere?
Technically, yes, it’s your own business, but you are applying for new credit with your mortgage lender. They are taking a chance by providing you with the funds to buy or refinance a home. They want to know the full truth of your credit history. Because new credit can often take time to show up on your credit report, a lender may want to know the story behind any inquiries on your credit report as there may be more than meets the eye on your credit report.
The best way for lenders to determine the reason behind the inquiries is to ask for a Letter of Explanation. This letter, which you write, should state the date of the inquiries, the lender reporting them, and the reason. You’ll want to be as detailed as possible in this situation because it could make or break your approval.
When Credit Inquiries can Hurt Your Approval
There is one instance when credit inquiries can hurt your approval – when they resulted in new credit. This means the lender has to go back to the drawing board and determine your debt ratio. If the new debt ratio is higher than the allowed maximum for the loan program, you may not be eligible for the program any longer.
This doesn’t mean every time there is an inquiry that you will get denied. If your debt ratio is still in line with the program’s requirements, you may still get approved.
The Reason for the LOX
Lenders want the Letter of Explanation to determine why you applied for new credit. It’s not always because they want to know if you took out new credit. They want to know why. For example, are you short on cash and need money quickly? This would be a red flag for the lender.
This is why you must be as detailed as possible in your letter. The lender wants to make sure that you didn’t need a loan to get the down payment for your home or to pay the closing costs. This money has to come from your own funds or from an approved gift. If it is a loan, the amount must be figured into your debt ratio to make sure you can afford the loan.
The best thing to do is be honest with your lender. The more you hide, the higher the risk that you will lose a previous approval. If you do have credit inquiries that led to new credit, let the loan officer know why. He may be able to help you with the letter of explanation to word it appropriately. He may also be able to help you choose a different program that would be more suitable if the original loan won’t work.