Many mortgage lenders use the Fannie Mae mortgage underwriting system for mortgage loans. Understanding the Fannie Mae system is in the applicant’s best interests. Home shoppers can get the best deal for themselves if they have a good grip on the process and what specific financial moves to make before they apply for a home loan.
In the past, when it came to revolving credit the important factors were whether the buyer paid monthly bills on time and how much debt he or she carried overall. The new underwriting system, effective June 25, 2016 will use trending data provided by TransUnion and Equifax to examine other financial habits during the 24 months before the initiation of a mortgage loan application.
It’s time for mortgage applicants to reconsider how they pay credit card bills each month
Trended data provides more details about how an applicant handles their revolving debt. In addition to revealing whether all payments were made on time and the percentage of credit used, the data will show each payment amount going back two years.
What are ‘transactors’?
The credit scoring system up until now has penalized some consumers who pay off credit card bills in full every month, considering only the credit limit and the amount of credit used.
The new underwriting system will evaluate applicants based on their payment amounts, casting a more positive light on borrowers who pay off their balances regularly, even if they also use much or all of their credit limits each month. Fannie Mae is calling these applicants transactors, and the new system is set up to reward them for responsible use of credit.
For example, Consumer A charges $5,000 to a credit card with a $6,000 credit limit each month, but then pays the balance down to zero when the bill comes. To the credit bureaus, he looks like he is using 83% of his available credit.
What to know: Under the new system, transactors are people who use credit responsibly by paying off their revolving debt each month. The new underwriting system will recognize these consumers as a lower overall risk.
What are ‘revolvers’?
People who carry a balance from month to month, perhaps paying only the minimum amount due, are called revolvers under the new system.
For example, Consumer B has a $6,000 credit limit and pays only the minimum amount due each month on a $2,000 balance. Her credit utilization rate is 33%, which is favorable.
If our two hypothetical consumers have identical credit reports except for their utilization rates, Consumer B has a higher credit score. The new underwriting system attempts to balance out that unfairness.
If credit card balances increase from month to month or the debtor only makes minimum payments, those financial habits will hurt the consumer’s chances of getting a mortgage loan.
What you should know: The ability to manage debt is an important factor in assessing risk for Fannie Mae. It may be more difficult for revolvers to get a mortgage after June 25th when the changes take effect.
Getting a mortgage under the new rules
There doesn’t seem to be a quick fix for the revolvers who hope to buy a home in the next few months. Throughout the application process, revolvers will endure more scrutiny where their income, overall debt, assets, and full credit report (including FICO score) are concerned.
Revolvers who want to get approved for a mortgage loan, but are able to wait 6-12 months have a few viable options to make themselves look better down the road.
Pay off the revolving debt in full
Even credit cards with zero interest are included in the new method of evaluation, so while it may make good financial sense to keep money in an interest bearing account and make smaller payments on this debt, bringing balances down will improve the trending data profile. Paying off revolving debt in full also helps the debt-to-income ratio, which is still a factor in a mortgage loan application.
Consolidate revolving debt
In some cases, trading one type of debt for another can help revolvers look better during the application process. Applicants should run side-by-side scenarios to make sure it’s worth any additional cost to consolidate revolving debt into an installment loan. This is a great time to ask for advice from an experienced mortgage lender.
Plan to pay off the revolving debt as quickly as possible
Most credit card users have heard of the debt snowball method for paying off revolving debt. Revolvers who want a mortgage may not have the means by which to pay off their revolving debt all at once. Start with the smallest debt and throw as much money at it as possible while making minimum payments on the others.
When the first debt is paid in full, move on to the next smallest debt, dedicating the money that would have gone toward the first debt, plus the payment you were already making on the second debt, plus any extra cash to paying it off. Move on to the next largest debt in the same fashion until all of the credit cards have a zero balance.
Stop using revolving accounts
Once balances are paid down, keep them as close to zero as possible during the months before, and throughout the application process. Some people have a hard time leaving an unused line of credit at zero. Running up the balances on a recently paid off credit card could ruin any chances of being approved for a mortgage under the new system.
Revolvers who don’t want to wait to purchase a home may have to settle for less house, or just wait and see what Fannie Mae’s new underwriting says about their credit worthiness.
The Ultimate Transactor Cheat Sheet: 7 Tactics for Paying Off Your Credit Card in Full Each Month
Written by: Nate Birt
If you apply for a mortgage after June 25 this year, you might encounter a few new challenges. Or you might find it easier than you ever expected.
The ease with which you get through the application process will depend, in part, on your ability to pay off your credit card each month.
That’s because new underwriting rules from Fannie Mae add greater weight to the practice of credit card repayment. Fannie Mae’s announcement says, in part, “A borrower whose revolving credit utilization is high and/or who only makes the minimum monthly payment each month will be considered higher risk as it indicates the borrower may have trouble making payments in the future.” Borrowers who carry revolving debt are called revolvers.
How do you make sure your credit card balance is paid in full from one month to the next, thus becoming a transactor instead of a revolver? Here are a few strategies that might work for you.
Tactic #1: Pay off your everyday card routinely
The only way you’re going to know how much you’re spending on your credit card is to keep an eagle eye on personal spending. That means monitoring your account on a regular basis. Some prefer to make payments weekly, while others make payments monthly. Also keep a running list of charges.
“That way you’re not surprised when the bill comes and you can plan ahead to be able to pay your bill in full,” advises Jennifer Abel, financial counselor and Senior Extension agent for Virginia Cooperative Extension in Arlington County. “There are lots of great apps that can help with this, but a simple way to do it yourself is to create a Google Doc in which you record each charge and what it was for. Put a link to the Google Doc on your phone so that you can log your charges as soon as you’ve made them.”
By keeping detailed records and paying off what you’ve spent on a regular basis, you can monitor card behavior in the context of your overall household budget. You can also earn points on your credit card while sticking to the spending plan established when the month started.
For Beverly Harzog, credit card expert and author of “The Debt Escape Plan,” using free online money management tools from Mint.com has proven especially useful for achieving this goal each month.
“I use Mint to track my spending and then automatic payments to make sure the bill is paid on time,” Harzog explains. “I pay the bill in full so I don’t pay interest on my purchases. Tracking my spending ensures that I won’t spend more than I can pay back in any given month. I tried different methods, and this approach worked the best for me. I’m a visual person, and the charts and graphs I can create with Mint really appealed to me.”
Tactic #2: Agree on a spending cap
Set a certain dollar amount each month that you and any other people with access to your credit card agree not to go above. This creates a mental benchmark for your spending and also imposes a cap. It’s easier to stop spending when you know the alternative is to panic about where the money will come from — and how much interest you’ll rack up if you let your balance slip into the next month.
“Pay attention to the table that appears on your monthly statement showing how much interest you would have to pay if you only make the minimum monthly payment,” Abel says. “Seeing how a $100 charge can turn into $300 if you take a long time to pay it off can be a great motivator to pay off charges all at once.”
Those with cash-flow challenges should register for text-message alerts or email reminders when credit card bills are due, Harzog adds. “This gives you time to make sure you have the cash in your account to cover the bill,” she says.
Tactic #3: Separate work expenses from personal ones
Set aside a credit card for work-related expenses only, and make sure to keep detailed records of receipts, card statements and any other documentation your employer requires. That way, you can file expense reports on time and be reimbursed quickly, enabling you to pay the monthly bill in full without penalty.
Tactic #4: Anticipate recurring bills
Barring an unexpected medical expense or a major appliance breakdown at home, few expenses are truly surprising. That’s why it’s up to you to know what recurring expenses you’ll face each month. These can include auto insurance, homeowners’ insurance and life insurance, among others. Don’t let occasional costs you might only pay once every three to six months throw off your credit card payment plan. Set aside money in your monthly budget for each of these known costs. That way, you’re not robbing Peter to pay Paul within your budget.
Tactic #5: Have an emergency fund in place
Have a rainy day fund in place, especially for the peace of mind it provides. It’s never good to let spending get out of control, but when you’re new to the process of budgeting, overspending is always a possibility. Establish a financial cushion for unexpected big expenses or times when you go over your spending limit.
Set aside at least $1,000 but plan to not use it. There’s no excuse for overspending on a credit card when you have a monthly budget outlined.
Tactic #6: Know where to trim
Most of us have a few flexible areas in our budget. They might include food, or entertainment, or occasional expenses such as clothing. Know where you can trim spending or put an entire expense on hold when you need the funds to cover credit card expenses. Again, this shouldn’t be a surprise, but having a contingency plan gives you a buffer.
Tactic #7: Do the math
Play the worst-case scenario game with yourself to understand the consequences of partial card payment. Likely fallout includes getting dinged on your mortgage application and paying interest on your existing expenses. It might not look too bad from where you’re sitting now, but the cost of debt adds up quickly and can cause you to lose financial momentum toward other goals, such as investing for retirement or saving for your children’s college funds. Plus, interest charges negate credit card rewards and, often, good deals on purchases. So you’re not doing yourself any favors by dragging the debt around with you.
You can net real savings by making purchases at a discount — but only if you pay off your card in full each month, Abel says.
Suppose a family of four visits the mall and buys a year’s worth of clothing and shoes for $1,000.
“You’re really proud of the shoes that you got for $40 that were marked down from $70, or the $300 business suit that you scored for $150,” Abel says. “When the bill comes and you only pay the minimum, it’s going to end up costing you $1,684 and will take you eight years to pay off that bill! (Assumptions: the minimum payment is 3 percent of your balance, and the APR is 18 percent.) The only way to really take advantage of sales is to pay your bill in full.”
The risk of getting into a financially tough spot is especially real if you carry more than one credit card, Harzog says.
“Once you start carrying a balance on one card, it’s easier to do that on another card,” she says. “Carrying a balance then becomes your new ‘normal’ and that’s a slippery slope to debt. So try out a few methods for tracking your spending and paying your bills. Find a method that makes you feel comfortable and stick to it.”