Having Your Loan Denied Due to Your Credit - Despite Having a Good Credit Score

Imagine applying for a mortgage for your dream home. You have good savings, a good job, very little monthly debt, and a decent credit score. Your loan approval should be a slam dunk, right? Now imagine how frustrated you are when the bank says your loan application was denied due to your credit report - despite having a good credit score!

Everyone knows that you need to have a good credit score to get the best rates and terms on a mortgage. But, many people don't realize that their credit report can cause them to be denied financing, despite having a good credit score. It's more important than ever to understand your entire credit history - not just your credit score itself.

Here's a list of five things on your credit report that can prevent you from getting a loan approval, regardless of the actual score. The first four are pretty straightforward. It's the fifth scenario that catches people by surprise and leaves them frustrated.

1. Having a bankruptcy in the past.

Most lenders won't approve your loan if the discharge date of your bankruptcy was in the recent past. The rule of thumb used to be that you had to wait two years after the discharge date before applying for a loan. But, nowadays, Fannie Mae has tightened her guidelines even more: two years after the date of a Chapter 13 and four years after the discharge of a Chapter 7.

Here's an example from a recent owner builder construction loan. The requirements called for a credit score above 620. The owner builder applicant had a score of 660. But, his loan was denied, because he had a bankruptcy that was discharged in 2005. With the new changes, he had to wait another year before getting approved.

2. Having a foreclosure on your credit report.

Similar to bankruptcies, a foreclosure can crush your chances of getting approved. Until recently, most banks would approve your mortgage as long as your foreclosure was at least three years in the past. But now, Fannie Mae is tightening the guidelines - you have to wait five years after the completion of a foreclosure. And, even then, Fannie Mae will require a 680 credit score and a 10% down payment. Otherwise, you're waiting seven years after the date of the foreclosure!

3. Having old collection accounts on your credit report.

If you have multiple collection accounts from your past that are still showing up on your credit report, there's a good chance that your credit score has recovered and is doing fine by now. But, if those accounts were never satisfied, a lender may require you to pay them all off prior to approving your loan.

4. Having a lien or a court judgment on your credit report.

If your credit report shows a lien or a court judgment in the Public Record Information section, then you might be denied financing until these items are satisfied. Here's one more example from the world of owner builder construction loans. A recent owner builder wanted to build his new home, and he had a great credit score. But, the credit report showed a court judgment still withstanding from five years ago that had never been satisfied. It was a small, petty amount of money for a very minor dispute in the past. But, he had to pay the judgment before he could proceed with his owner builder loan.

5. Not having enough open accounts that are over two years old.

The first four scenarios above are pretty straightforward. It's easy to understand that something negative like a court judgment or a foreclosure on their credit report could prevent financing approval. But, this fifth scenario is different. How could you possibly be denied a mortgage despite having a good credit score with no derogatory accounts showing on your credit report?

The answer is that the credit report might not have enough accounts showing at all. In other words, your credit score may be fine. You may not have any negative things showing from your past on the report. But, if you don't have at least a few open accounts that are over two years old, then you might get denied financing.

For example, a recent owner builder applicant had a 673 credit score. His other loan qualifications fit well with the program guidelines. But, he was denied an owner builder construction loan because he had closed all of his credit cards. He only had one open account showing on his credit report. He thought at the time that he was doing the right thing.

In some ways, he was doing the right thing - he didn't have excessive car loans or credit cards. He didn't run up a lot of debt. He lived within his means. But, on the other hand, his credit report wasn't showing enough open accounts to approve the loan. The owner builder loan was denied, because of a lack of current, responsible credit use (i.e., no credit use). In the case of this owner builder, his owner builder construction loan would have been approved with flying colors if he had simply paid off the credit cards, but left the accounts open with zero balances.

Therefore, when you are reviewing your own credit report, make sure you have at least three open accounts that are each two years old - with no late payments. This is tough for some people who are young and haven't had the time yet to establish a lot of credit. In cases like this, the easiest thing to do is to get a few credit cards while in school. The tricky part is to have the discipline not to run up balances on those cards. And, in the end, that's the whole idea - lenders nowadays are looking for evidence of responsible use of credit.