When it comes to financing your dream property in the country, the better prepared and informed you are, the easier the process will be. In the credit world, what you don't know can hurt you. Realizing what a loan officer looks for, and understanding how credit decisions are made, can help ensure you get the credit you deserve long before you need it.
Many loans today -- especially smaller loans -- require less paperwork than in the past. Nonetheless, some financial records typically still are required to verify a borrower's ability to repay a loan. This is particularly true if you are self-employed or have changed jobs recently.
A borrower can dramatically speed up the loan application process by gathering some commonly requested financial records before the loan interview. Things to bring include:
Three to five years' tax returns if you are self-employed or have had an employment change. "The tax returns help us understand the sources of income, as well as trends in income," notes Jessie Purvis, senior vice president/chief administrative officer with the Federal Land Bank Association of South Mississippi.
A balance sheet showing assets and liabilities. "You don't need a CPA to do this. Usually between the loan officer and the applicant, we can get pretty close," says Purvis.
Salary verification, especially if the applicant has recently changed jobs or has been promoted.
The property's legal description and a copy of the purchase agreement, if you're buying real estate.
Know the Score
In recent years, lenders increasingly have turned to credit scores to make faster -- and sometimes on-the-spot -- loan approval decisions, especially on smaller loans. Even on larger loans, an applicant's credit report and credit score are factored in with additional detailed credit analyses to determine an applicant's creditworthiness. Because credit score can impact everything from getting the best rate on a car loan to qualifying for a mortgage or line of credit, it's critical that consumers maintain the highest credit score they can. According to the Federal Trade Commission Web site, www.ftc.gov, your credit score is determined by several factors in your credit report:
- Payment History - Any negative information, such as missed payments, may remain on your report for seven years. Bankruptcy may remain for 10 years.
- Outstanding Debt - While it is important to have some credit cards, too many cards or lines of credit have a negative effect on your score.
- Length-of-Credit History - Credit-scoring models value a long credit track record. Good repayment performance with the same lenders over long periods of time has a positive influence on your score.
- New Credit Applications - "Many department stores offer purchase discounts if you apply for their credit card, and while you may save a few dollars on that purchase, applying for too many credit cards can negatively impact your credit score," notes Tim McDonald, senior vice president/chief credit officer, Great Plains Ag Credit, Amarillo.
The Five Cs
The "Five Cs of Credit" are the basic factors upon which lenders base loan decisions. They are:
1. Character - the borrower's honesty and integrity. "Character is ranked at the top of the list, because weakness in this credit factor generally can't be compensated for with other credit factors, no matter how well the loan is collateralized or capitalized," notes McDonald. To assess an applicant's character, lenders look to business and personal references and credit reports, among other variables.
2. Capacity - the applicant's financial capacity to repay the loan. A general rule of thumb is for this to exceed a 1.1:1 capacity ratio. In other words, after all living expenses and taxes are covered, lenders look for at least $1.10 of income for every $1.00 of debt that must be paid each year.
3. Capital - the applicant's liquidity and solvency. "The lender must be sure that the applicant has enough equity in his or her assets to secure operating loans and to take care of unexpected circumstances," says Purvis. While the percentage of owner equity varies based on the nature of the loan, in general 50 percent owner equity is a good target. To determine owner equity, divide your net worth (assets minus liabilities) by your total assets.
4. Collateral - the physical property that will minimize the lender's risk in the event of default. In the 1980s, many collateral-based lenders got "burned" by the fickle nature of fluctuating land values. That's why Farm Credit lenders place collateral toward the bottom of the credit criteria list. "The last thing any Farm Credit lender wants to do is take back a piece of collateral," says McDonald. "We put the emphasis on the character factor, because the single most important factor in repaying that loan is the individual."
5. Conditions - the conditions for granting and repaying the loan. Farm Credit's specialized lending experience enables loan officers to structure loan packages uniquely tailored to rural borrowers. "Many of our customers don't have a typical monthly paycheck," says Purvis. "We often have more loan choices available than commercial banks have, and can structure virtually any loan arrangement from monthly to semi-annual or annual payments -- or we can split loans so they mature at different times to fit the customer's stream of income."
Loan officers agree, the best advice to loan applicants is this:
Place a high priority on maintaining a strong credit rating, keep good records and look for a lender with flexible loan offerings that can adapt to your unique situation.
– Sue Durio
Clean Up Your Act
A clean credit report can mean the difference between getting a loan or not. To make sure your credit report is healthy, loan officers make these recommendations to customers:
Get a copy of your credit report. By June 30, 2005, consumers in the five-state Tenth District territory -- Alabama, Louisiana, Mississippi, New Mexico and Texas -- will be able to obtain a free copy of their credit report once every 12 months through the three nationwide consumer reporting companies, Equifax, Experian and TransUnion. By Sept. 30, 2005, consumers in all 50 states will have access to their credit reports at no charge. To order your free report, visit their central Web site at www.annualcreditreport.com or call 1-877-322-8228.
Cancel dormant credit card accounts. Once a credit card balance is fully paid off and you don't intend to use the card again, cancel it first by phone and then follow up by certified mail. Request a return receipt. After a month or two, check your credit report to be sure it shows the account "closed at customer's request."
Clear up mistakes. If you spot mistakes on your credit report, send a certified letter, return receipt requested, to the reporting agency with copies of documentation as support. The agency has 30 days to investigate the issue. The three major national credit bureaus are:
P.O. Box 740241, Atlanta, GA 30374-0241 800-685-1111
P.O. Box 2002, Allen, TX 75013 888-397-3742
P.O. Box 1000, Chester, PA 19022 800-916-8000