How To Qualify Borrowers: Know A+ From F Credit Rating

Remember that you make the rules about how you invest your money for private mortgages. Some private mortgage investors just say they want 15% p.a. interest and won’t go above a 65% Loan to Value ratio no matter how good the credit of the borrower. And that’s an OK rule too. Our purpose here is explain the relationship between risk and reward so you won’t get talked into a bad deal. Learn how to understand FICO credit scores from A+ to F to make the best decision for your money.

In this Article

Is your Borrower an A+ or an F?

First determine the credit class of the borrower. You can do this on the table below:

FICO is the credit score you will find for the borrower when you review their credit report. Cash down is the actual cash money that the borrower will be paying at closing as a percentage of the sales price. For these purposes a reasonable guess is OK.

What is a FICO Credit Score?

FICO scores come from the Fair Isaac and Company, hence the initials. FICO scores typically range from 300 to 850. Scores between 740 and 850 are generally considered excellent, while scores below 580 are considered poor.

Factors Influencing FICO Scores

• 35% Payment History: Late or missed payments can significantly lower your score.
• 30% Amount Owed: Owing a large amount relative to your credit limits can indicate that you are overextended, but it’s important to note that credit utilization (how much of your available credit you’re using) is key.
• 15% Length of Credit History: The longer your credit history, the better.
• 10% Credit Mix: This portion of your score is based on having a healthy mix of different types of credit (e.g., credit cards, loans, mortgages).
• 10% New Credit: The number of recently opened accounts and credit inquiries affects this part of the score, not 20%.

Credit Utilization Impact on FICO Scores

It can adversely affect your score if you close down several credit cards and consolidate them. Here’s why:

Let’s say you have 4 credit cards all with a $5,000 limit. You owe $1,000 on each. You are using 20% of your available credit. Now assume you transfer The balances of three of the cards to one of them and close the other three. You still owe $4,000. And you are within your $5,000 credit limit, but you are now using 80% of available credit.

Don’t go buying furniture for your new home on credit shortly before closing. An institutional lender will re-check your credit score just before closing and these new items could mean you no longer qualify for the loan!

Impact of Closing Accounts on FICO Scores

Closing credit cards can negatively impact your credit utilization ratio, and it can also reduce the average age of your credit accounts, which may further lower your score.

Lender Guidelines: Understand Credit, Capacity and Commitment

As a lender, the list below contains the vital information you need to make an informed decision BEFORE you agree a loan. You want to know your borrower’s Credit, Capacity and Commitment to your loan:

• Credit. Past credit history of the borrower. If the borrower doesn’t pay anyone else, they may not pay you. We can email you a credit report. In general, the lower the credit score, the worse the credit. It is important to distinguish between GENUINE short term problems, like a divorce or being laid-off, and deadbeats who never act responsibly.
• Capacity. Does the borrower earn enough to make the payments? When you verify employment, be aware that some crafty borrowers will give a friends phone number as the number of their employer. Listen when you make the phone call. Would you expect to hear children in the background if you called, say, General Motors? You will want to see a W2, perhaps tax returns and Verification of Employment (VOE). See options for VOE below.
• Commitment. How much does the borrower have at risk of his own money? Ask for the closing statement for when the property was bought or is going to be bought. Always insist the borrower has some of their own money at risk. Ask for a copy of the bank statement of the borrower showing where the check for the binder was drawn. In a similar way to the VOE, you should get a Verification of Deposit (VOD). See options for VOD below.

What about Collateral?

Along with Credit, Capacity and Commitment there is Collateral. Learn about Mortgage Collateral.

Options for Verification of Employment (VOE)

To verify the borrower’s capacity to make payments, It is essential to verify your borrower’s employment and there are several options. it could be as simple as having them fill in a form, or there are digital services. Either way, you need to make sure you are receiving convincing information to prove your borrower will have the capacity to make their payments.

1. The Work Number (Automated Employment Verification Service)

The Work Number by Equifax is one of the most widely used employment verification services in the U.S. It provides automated access to payroll records from participating employers. Lenders can quickly verify a borrower’s employment status and income via this secure platform, which contains data from thousands of employers.

• Benefits: Fast, accurate, and requires minimal input from the borrower.
• Drawback: Only works if the employer participates in the service.

2. Digital Verification Platforms (Fintech Solutions)

Fintech solutions like Truework, Plaid, and CertifID offer digital employment verification services. These platforms often integrate directly with payroll systems or provide tools to request verification from employers electronically.

• Benefits: Instant access to employment records, reducing verification time and errors.
• Drawback: May require consent from the borrower to access payroll systems.

3. Employer Direct Contact

Lenders or verification agents still often contact employers directly via phone or email to verify employment status and income. They typically speak to a representative from HR or payroll departments.

• Benefits: Can be used when automated systems are not available.
• Drawback: Time-consuming and subject to delays if employers are unresponsive.

4. Employment Verification Letters

Borrowers can provide employment verification letters from their employers. These letters typically confirm the borrower’s position, income, and employment status.

• Benefits: Simple to obtain for many employees.
• Drawback: Verification still needs to be authenticated to prevent fraud.

5. Bank Statement and Payroll Review

In cases where direct employer verification is not available, lenders may use bank statements to confirm the borrower’s income deposits. Reviewing the consistency of payroll deposits can serve as indirect proof of employment.

• Benefits: Convenient and digital.
• Drawback: Doesn’t verify employment status, only the consistency of income.

6. IRS Form 4506-T

Lenders can request IRS Form 4506-T (Transcript of Tax Return), which provides a transcript of the borrower’s income reported to the IRS. This helps verify whether the reported income matches the borrower’s claims.

• Benefits: Reliable and IRS-authenticated.
• Drawback: Delays in processing.

7. Self-Employment Verification

For self-employed individuals, verification typically involves reviewing tax returns, business bank statements, profit and loss statements, or 1099 forms.

• Benefits: Provides a detailed look at the borrower’s financial health.
• Drawback: More complex than verifying traditional employment.

8. VOE (Verification of Employment) Forms

Lenders may request the borrower to have their employer complete a Verification of Employment (VOE) form, which provides detailed employment information.

• Benefits: Direct confirmation from the employer.
• Drawback: Can take time for the employer to process.

Options for Verification of Deposit (VOD)

To verify the borrower’s commitment to your loan, you should make sure they have their money on the line too and you are not giving them 100% or very high levels of finance. There are various options for verifying you borrower has the financial means to pay a down payment and, that it is their money they are using. You wouldn’t want to be in a situation that the borrower has borrowed money to put down at closing from someone else, and will need to make payments on that too. They could just walk away from you both.

1. Direct Request to the Financial Institution (Paper Form or Online Request)

The most traditional way of obtaining a VOD is to contact the financial institution where the borrower holds their accounts. Lenders may request that the borrower’s bank complete a VOD form, which provides detailed information about the borrower’s account balances and history.

Paper Form: Lenders can send a physical VOD form to the bank via mail or fax. Online Request: Some institutions have online portals where VOD requests can be submitted and processed

• Benefits: Direct and typically reliable.
• Drawback: Can be time-consuming, especially if relying on manual processes or if the bank takes time to respond.

2. Automated Verification Services (e.g., The Work Number for Banks)

Similar to employment verification services, some platforms offer automated VOD services. One such service is The Work Number, which can also provide deposit verification through partnerships with banks. Lenders can use these services to instantly verify account balances, transactions, and account status without waiting for manual processing.

• Benefits: Fast and efficient, usually real-time verification.
• Drawback: Not all financial institutions participate, so coverage can be limited.

3. Digital Fintech Platforms (e.g., Plaid, Yodlee)

Fintech platforms such as Plaid and Yodlee offer digital, real-time access to a borrower’s bank accounts, enabling quick and secure verification of balances and transaction history. These platforms connect directly to a borrower’s financial accounts after obtaining the borrower’s permission. The lender can then access detailed financial data to perform a VOD.

• Benefits: Immediate and secure access to real-time data.
• Drawback: Requires borrower consent and financial institutions’ participation in the platform.

4. Bank Statements

Another common method is to ask the borrower to provide recent bank statements (e.g., the last 2-3 months of statements). These statements can show current balances, average balances, and account activity. Lenders will review these documents to verify deposit information manually.

• Benefits: Easily accessible by the borrower, no waiting for bank processing.
• Drawback: Requires lender to manually review statements, and might not provide the same level of verification as a formal VOD request.

5. Third-Party Credit Reporting Agencies

Some credit reporting agencies include bank account verification as part of their reporting process. Lenders may obtain VOD information as part of a larger credit report, particularly from companies that offer expanded services.

• Benefits: Can be included as part of a broader credit verification process.
• Drawback: Not all agencies provide this service, and it may come with additional fees.

6. Borrower-Generated VOD Request

In some cases, the borrower themselves may request a VOD from their bank and provide it to the lender. The borrower contacts their bank, fills out the necessary forms, and submits the verified document to the lender.

• Benefits: Can save time if the borrower is proactive.
• Drawback: Adds an extra step for the borrower, and there is a risk of delays if the bank takes time to process the request.

7. IRS Transcript or Bank Report

Lenders can also use the borrower’s IRS tax transcript (via IRS Form 4506-T) or other tax-related financial reports to verify income and deposit details, particularly for self-employed individuals. Although this is less common than a direct VOD, it can serve as an additional method to verify financial background.

• Benefits: Reliable government-provided data.
• Drawback: May not provide current or detailed account balance information.

Conclusion

As a lender you want to be paid and your choice of borrower will determine whether this happens. You set your loan terms. If a borrower is not paying anyone else, why would they pay you? A borrower with a good to excellent FICO score and 25% down payment, is preferable to a borrower with a much worse score and little or no downpayment. It’s much easier for a borrower to walk away if they don’t have a sufficient down payment, meaning they have little or no “skin in the game”. Learning to evaluate credit ratings from A+ to F allows you to make informed decisions about your investments and minimize exposure to unnecessarily risky borrowers.

Always ensure you verify the borrower’s credit, capacity, and commitment to your loan. Understanding their financial stability and background through tools like Verification of Employment (VOE) and Verification of Deposit (VOD) is crucial.

Further Reading on Credit Scores and Borrowers:

• Learn about the Landlord FCRA Compliance Advice: What You Need to Know.
• Understand Credit Report: Reasons Needed and How to Make Sense of them.
• Learn How To Pre-qualify a Hard Money Mortgage with our online Calculator.

DISCLAIMER: We are not attorneys and we cannot advise you regarding your particular circumstances. You must always obtain competent legal counsel and financial advice. We believe this information to be accurate, but please check with a qualified real estate attorney in your state before making any decision based on this information.