Denial of credit: the ultimate (or penultimate) step of the loan application process

A homebuyer’s agent, called a transaction agent (TA) by lenders, is duty bound to assist his buyer to navigate the intricacies of the loan application process in order to obtain the purchase-assist financing needed by the buyer to close escrow. Mortgage financing is integral to nearly all purchases by homebuyers. Without purchase-assist financing, most prospective homebuyers would be unable to purchase the home of their choosing. This is especially true for vulnerable, first-time buyers who do not have the proceeds from the sale of another home for a down payment on a property.

Thus, the outward conduct, psychological motivations and internal processing of the chosen lender must be known by the TA to best assist this homebuyer to surmount this intimidating step of applying for a loan. And on a purely practical level, if the homebuyer is unable obtain financing to purchase a home, the TA is prevented from receiving a fee after expending significant amounts of his time and expertise to negotiate the purchase offer and conduct his due diligence investigations.

As the buyer’s and TA’s economic fates are intertwined, it is a loss for both when the buyer’s loan application is denied by the lender. Denial is an unpleasant occurrence to be sure, but it doesn’t end the TA’s obligation to assist the buyer to acquire a home. The TA must be able to knowledgably advise his buyer about the loan application techniques in both good times and in bad – and perhaps the TA’s counsel with the buyer is most appreciated when things go awry, such as when a lender, relying on a credit score, sends a copy of the credit report with derogatory confirmation to the buyer or denies a loan application and the buyer wants to know what actions can be taken.

If adverse action is taken by a lender on a homebuyer’s application for a purchase-assist loan (such as denying the buyer a loan or offering a loan on different terms from the application), the lender will hand the buyer a denial of credit form. [See first tuesday Form 219 accompanying this article]

Lenders are less inclined to issue financing, or offer financing on lesser terms, to buyers with derogatory items on their credit report since derogatory items may indicate the buyer presents an increased likelihood of default.

In the denial of credit notice, the lender to close out his file will provide the buyer:

  • written notice of the adverse action taken;
  • a statement that the lender’s decision to take adverse action was based in whole or in part on a credit report, including the name, address, and phone number of the credit reporting agency which issued the report; and
  • a notice detailing the buyer’s right to:
    • obtain a free copy of his credit report from any national credit reporting agency within 60 days; and
    • dispute the accuracy or completeness of any info in the credit report. [Calif. Civil Code §1785.20; see Form 219]

The lender will also indicate the specific reason(s) the adverse action was taken, such as:

  • the buyer’s delinquent payment of debts;
  • inadequate references provided by the buyer to establish credit;
  • derogatory trade references exist; or
  • the failure of the buyer’s references to respond to the lender’s verification requests. [See Form 219 §3]

Once the denial of credit has been handed to the buyer, the TA can advise the buyer to respond in one of two ways:

  1. continue to seek financing from the same lender which gave the denial of credit; or
  2. seek financing from another lender.

If the buyer chooses to pursue financing from the same lender, he may submit a written request for the reason his credit was denied within 60 days after receiving denial of credit. [Calif. Civil Code §1787]

On the initial receipt of a denial of credit notice, the TA needs to review the notice and the buyer’s credit report and identify the derogatory credit issues. With the guidance of the TA, the buyer may need to prepare and submit a Derogatory Credit Explanation Letter to the lender. The Derogatory Credit Explanation Letter is designed to provide a personalized explanation for each derogatory item appearing on the credit report. The explanations establish the external historical context surrounding the rise and resolution of the derogatory items not shown on the credit report. [See first tuesday Form 217-1; for more information regarding other uses of the Derogatory Credit Explanation Letter, see the January 2010 first tuesday Form of the Month]

This candid response to the credit report is considered favorably by lenders when determining creditworthiness, and often makes the difference between approval and funding, or a denial of the second attempt to obtain financing. [See first tuesday Form 217-1]

If the lender still elects not to extend financing to the buyer, the buyer has no other option but to seek a loan through another lender if he is to pursue the purchase. The discouraging event of a denial wrought by the lender does not end the TA’s duty to the buyer. If the buyer still wants to own a home, and since the TA wants to earn a fee, the TA needs to guide the buyer to other avenues of financing, such as a credit union, community bank or a lender of a different size or demographic constituency from the lender denying the loan.

Even after the dreaded denial of credit kills the loan, the experienced and thoughtful TA will not let it kill the deal – or his buyer’s dreams of homeownership.

Editor’s note – One preventative step in anticipation of a change of heart by a lender during the loan approval process is to submit loan applications to two lenders concurrently as protection against surprises. [For more information regarding the loan application process and the advantage of submitting multiple applications, see the May 2009 first tuesday article, Loan applications initiate the loan process.]