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Red Pear Realty's Guide to Mortgages

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A. Intro
B. Mortgage Basics
C. Steps in Obtaining a Loan
D. Factors Determining Interest Rate
E. Non-Conventional Loans
F. Other things you should know
G. Glossary/Abbreviations


A. Intro

This is meant to be a introductory guide to all things mortgages--from conventional to non-conventional. We will discuss the steps in a loan process, factors that determine your interest rate, non-conventional loan products, and some other things you should know. Over time, we will update this post if items change. If you have questions, would like some lender recommendations, or would like to discuss buying or selling a home in Texas, you can PM us here, email us at Office@MyRedPear.com, or text/call us at (832) 491-8000.


B. Mortgage Basics

1. What is a Mortgage?
A mortgage is a debt instrument that is collateralized by real property, with a promise by a borrower to repay over a set period of time.

2. How do you Qualify?
All lenders are different. While loans backed by Fannie Mae and Freddie Mac must comply with certain guidelines, lenders have the flexibility to be stricter with items the industry refers to as "overlays" or to not offer certain loan products as a business decision. An example of an overlay is that one lender might not accept income from short term rentals like AirBNB for the purposes of calculating your DTI, while others might. This is why we will state repeatedly here that if one lender tells you that something isn't possible, don't give up, another lender might have exactly what you need.

3. Mortgage Math
While advanced users can model debt in Excel, there are free online options that work just as well, like https://www.mortgagecalculator.org/.

4. APR
APR is the interest rate on your loan plus other selected costs associated with that loan, expressed in terms of an interest rate. APR can be an easy way to compare loan products against other loan products or lenders against lenders.


C. Steps in Obtaining a Loan

1. Know your credit score
Once per year, you can get your actual credit score from each of the three credit reporting agencies (Experian, TransUnion, and Equifax) for free at http://www.annualcreditreport.com/. Your actual Mortgage credit score can be very different from the "free" online sources elsewhere. Lenders use the middle of the three scores or the lower of the two if all three are not reporting.

2. Get to Know a Couple of Different Lenders
As long as you receive quotes from various lenders within a (approximately) 7 day window, the totality of your credit pulls from all those various lenders only counts as one credit pull on your credit report. This is so that you are not discouraged from getting multiple quotes. As we will discuss later, this is not just to see who has the cheapest rate. Your lender is going to be your partner in closing your loan. Pick a bad horse and it could end up badly.

3. Submit Application / Docs
Each lender will ask for your full financial situation via an application, and if you decide to move forward with that lender, they will require a lot of supporting documentation such as bank statements, W-2's, paystubs, IRS filings, etc.

4. Rate Lock
You are not set with a lender until you lock rate. This comes at a cost to your lender, so do not lock rates with a lender unless you plan to proceed with them. Many lenders will not lock your rate without a signed contract on a purchase or a completed application with an appraisal ordered on a refinance.

5. Initial Disclosure
Dodd Frank requires that all lenders disclose your rate, fees, estimated closing costs, and terms at the time of rate lock. You should expect that these amounts are provided conservatively and should be no higher at closing time.

6. Initial UW Review
An Underwriter will look at your application and documents and your credit report and tell you if you qualify or not. Expected time frame for review will vary lender to lender and type of transaction. Most lenders will prioritize purchase transactions over refinances.

7. Conditions / Conditional Approval
If you qualify, your underwriter will most likely have follow up requests for additional information or supporting documents. These are called "Conditions".

8. Submit Documentation
When you get your conditions, provide the underwriter with their requested items ASAP! Don't delay your loan and closing as this could cost you money.

9. Follow Up UW Review
The UW team will then review everything again and repeat until the loan approval is met.

10. Appraisal
The lender will lend on the lower of the contract price or the appraised value. There are certain situations where your appraisal could be waived, and if this is offered to you, you should take the lender up on it.

11. Clear to Close
Assuming everything above goes in your favor, you should receive your CTC. This is exciting! DON'T DO ANYTHING TO CHANGE YOUR CREDIT PROFILE BEFORE RECEIVING YOUR CTC AND CLOSING. Don't apply for additional credit cards, don't buy a car, don't pay off old debts, don't finance a TV, etc.--you could blow up your deal.

12. Closing Disclosure
Dodd Frank requires that you be disclosed of your final loan terms and costs at least 3 days prior to closing. Please let us help you review your final CD to make sure your Red Pear Realty rebate gets applied appropriately, and as a second set of eyes on everything else.

13. Closing Day / Funding
This is the finish line. Get excited! Have your pen ready, because you are going to sign documents like crazy.

Speaking of documents, you have two paths available on closing day. In the first, you sign docs as the title agent slides them to you. Closing will take 30 minutes to an hour. In the second path, you read every word of every page that is handed to you...and this will likely take around 4 hours or more. Not pointing any fingers, but we are looking at you, engineers. The reality is that by this point, dozens of people have reviewed your closing docs and figures, and while we are all human, the likelihood that there is a mistake is very, very small. And finally, one of the pages you will sign at closing states that if there is an error on your closing docs, you agree to come back to title to fix it. And if you don't sign, you will not fund and receive your keys. So you need to be aware of the pros and cons of each approach.


D. Factors Determining Interest Rate

1. The Market
Contrary to what you might have heard, the Fed does not set interest rates for mortgages, the free market does. So the biggest chunk of your interest rate will be determined by how the economy is doing, where the market thinks the economy is headed, inflation, jobs, growth, etc. You have no control over this part other than doing your part to help the economy by earning and spending. However, all items following this one ARE under your control.

2. Purpose of the Loan
Is this your primary residence? Secondary/Vacation home? Rental? Purchase or Refinance? Each of those scenarios will give you a different risk profile and therefor a different interest rate. The best rate will go to a primary residence. Some lenders don't distinguish between primary and secondary/vacation homes, but many do. Rentals will typically be ~50 bps higher than Primary loans, and secondary/vacation homes are usually an eight or quarter higher with some additional LTV requirements.

3. Your Credit Score
Credit scores can range from 300 to 850 and in the US are determined by the three Credit AgenciesExperian, TransUnion, and Equifax. Typically, lenders will run all three scores on a borrower, then base your interest rate on the middle number of those three scores. Assume tiers of interest rates depending on your credit score:

740+ The best rates
700-739 Slightly higher rate than above
640-699 Qualifies for conventional loan with slightly higher rate than above
580-699 FHA loan with 3.5% down payment
500-579 Only qualify for FHA loans with 10% down payment
300 to 499 Do not Qualify for any loan product

*Many lenders will have overlays that set a higher minimum credit score.

4. Loan to Value (LTV) Ratio
The safer your LTV, the better interest rate you'll get. For a long time, I didn't really understand what this meant. I mistakenly thought higher LTV equates to higher interest rate, but that's not necessarily the case. With conventional loans you'll need to put at least 5% down on a primary and at least 20% down for rentals (yes you might be able to do less than 20% down but the interest rate gets stupid fast). You'll get the best interest rate with 25% or more equity in a home. At 20% equity, you are not required to pay PMI, but you'll usually get a worse interest rate than if you put down 10% but were required to pay PMI. At 5% down, you'll get the highest interest rate offered, and with any LTV greater than 80%, you'll be required to pay PMI until your LTV drops below 78% by making payments, or below 80% if you pay for an appraisal that shows the value has increased. So your loan at 10% down with PMI could be considered safer to the lender than the same loan with 20% down.

5. Loan Size
A loan costs the same to underwrite and service regardless of whether it is really small or really big. In general, the larger your loan size (up to the Jumbo limit), the better interest rate you'll get, and vice versa. Most lenders won't even consider underwriting a deal under a certain loan amount (say $80,000) because of this.

6. Loan Term
Loans are typically offered on a 30, 15, 20, 10, or 5-year amortization schedule. In normal economic times (not 2020/2021), a longer term equals higher rate. So usually, a 15-year mortgage will have a better interest rate than a 30 year. In times of economic stress, shorter duration instruments can become more expensive as investors seek short term safety. The proper term for this situation is an "Inverted Yield Curve" and we are actually in this situation right now.

7. Rate Lock Period
Typically, your lender will agree to lock, or "hold" your interest rate for either 30, 40 (most common), or 60 days until you close. The shorter amount of time you need to close, and therefore lock, the better interest rate you'll get.

8. Cash Out Refi
When you refinance a property, if you cash out built up equity, you'll get a higher rate than if you didn't cash out in that same refi. Right now, we typically see around a 50-bps spread.

9. Non-Married Co-Habitants
Some lenders give better interest rates to married co-habitants because their default rates are lower.

10. Buyer Paid Points / Lender Paid Credits
From my experience, this is the most misunderstood aspect of getting a loan for most buyers. Most people just care about their interest rate because that's what affects them long term but coupled with every rate is an amount of Buyer Paid Points "Points" or Lender Paid Credits "Credits". Think of your mortgage cost as a matrix of options or combinations of rates and associated points or credits. Here's an extremely oversimplified and exaggerated example of options that might be offered to a borrower for a certain loan:

4.00% - $6,000 in Credits
3.00% - $5,000 in Credits
2.875% - $2,500 in Credits
2.75% - PAR
2.625% - $2,000 in Points
2.50% - $4,500 in Points
1.99% - $20,000 in Points

So how do you decide which option is right for you? It's a very simple mathematical equation, but the decision is really up to you. For the math part, take your loan balance, amortize based on your term and the interest rates above. Each option will have an incremental cost or savings, which you then divide by the amount of points or credits you'll get. The result is how many months you would need to keep the house before selling in order to break even.

Example:
A $300,000, 30-year fixed loan at the par rate of 2.75% would cost you $1,224.73 per month in principal and interest.

A $300,000, 30-year fixed loan at 2.625% would cost you $2,000 in points but would reduce your principal and interest amount to $1,204.95 per month. This would be a monthly savings of $19.78.

Paying $2,000 in upfront costs will save you $19.78 per month. $2,000 divided by $19.78 is 101.11, so if you believe you will own this home for more than 101.11 months, it might be worth it to pay the points. If less, then not worth it. This also doesn't take your opportunity cost into consideration, but close enough.

What I would tell you is that there is no universal right answer for which option every borrower should select because everyone's situation is different. One borrower might want a little help covering closing costs and knows that they will 100% sell when they are promoted and move in less than 4 years, so an option with a lender credit might be a good idea. Another borrower might know that this will be their last home and that they are never moving again, so paying $4,500 in points to get a lower rate for 360 months might be 100% worth it. Another borrower might REALLY enjoy telling his buddies and posters on TexAgs that he got a 1.99% 30-year mortgage, so paying the $20,000 in points might be more than worth it.


E. Non-Conventional Loans

Loan products are just like shopping for any other product. One seller (lender) might offer a bit of everything, another might only do conventional loans, and another might specialize in a niche product. One of the best pieces of advice I can give you is that just because one lender or a couple of lenders tells you no, doesn't mean that what you are trying to do is impossible. These non-conventional loan products might be the best for your situation.

1. FHA Loans
Good for first time homebuyers. As little as 3% down but come with additional costs. Lenders make 10x on these, so be cautious and understand why an FHA loan is the best option for you if your lender suggests this route.

2. VA
If you are a Veteran, this is the way to go. You can put as little as 0% down (and add your closing costs to the loan balance, so truly have a home for $0 out of pocket) with no PMI cost to the borrower. Experienced lenders and agents know that VA loans are not that different from other loans, but there is still a stigma attached to VA loans that is sadly spread by sellers' agents and lenders who are in short, ignorant. If you are going the VA route, work with a buyer's agent and a lender who can educate sellers agents or structure your offer such that you don't put yourself at a disadvantage. VA loans typically price 50 bps lower than their conventional counterparts.

3. ARMs
An ARM has a set interest rate for a certain amount of time, then adjusts periodically after that term expires. So a 5/1 ARM would have a fixed interest rate for 5 years, then adjust depending on where interest rates are once per year after that. Usually there is a minimum upward adjustment that almost guarantees the interest rate will rise 2.00% or so after the initial term expires. During normal economic times, ARMs can be a very attractive option for someone that knows they will be selling or refinancing in less than 10, 7, or 5 years, however, when the yield curve is inverted, like it is now, ARMs are actually MORE expensive. You should not use this to help you qualify for a loan you otherwise wouldn't qualify for or be comfortable having.

4. Jumbo Loans
Jumbo loans are for borrowers looking to finance more than the amount allowable in the guidelines established by the Federal Housing Finance Agency (FHFA). The theory is that the federal government should encourage and support regular folks owning homes, and people wanting more can take care of loans without the help of Uncle Sam. Jumbo loans cannot be purchased by Fannie Mae or Freddie Mac, must be kept on the balance sheet of a lender, and therefore usually get higher rates because of that. Borrowers need excellent credit, higher down payments, and high incomes or balance sheets to qualify. As an example, the 2021 Conventional Loan Limit for Harris County, and most of Texas, is $548,250 for a single-family home (this is also the national floor), but the conforming loan limit varies from county to county across the country. Jumbo loans typically price at least 50 bps higher than conventional loans.

5. Construction Loans
Construction loans come in many shapes and types, many of which could be right for your specific situation. Most are either a loan for construction which requires a takeout upon completion, or a loan that automatically converts at the time of completion.

6. Rural / Recreational Loans
Rural properties are often unique, and many conventional lenders do not offer products for this property type. Conventional loans typically have a maximum lot size of 5 acres, so with a rural property, it often makes sense to finance through a lender who specializes in rural properties, or to split the property into two tracts and finance each separately: (1) the improvements and up to 5 acres, and (2) the remaining portion of the land.

7. Vacant Land Loans
Typically have a 15- or 20-year loan term (but can be amortized over 30 years), and have higher down payment requirements (typically a minimum of 15% down).

8. Hard Money Loans
Hard money is often used by flippers for a very specific purpose and short amount of time. Interest rates on hard money loans are around 10-12% right now plus a point or two up front. You cannot get hard money loans for your primary residence due to foreclosure restrictions added by Dodd Frank.

9. 203k Loans
This is good for a homeowner that wants a house that needs a bit of work but maybe doesn't have the cash to pay for those renovations up front. Repairs must be cosmetic, not habitability issues. A loan is provided for the house and an escrow account is set up for renovations. Not offered by a lot of lenders because they are less profitable.

10. Others
There are MANY more non-conventional loan products out there. If someone tells you that what you are looking for doesn't exist--don't get discouraged, keep trying.


F. Other Things you Should Know

1. How Lenders Get Paid
Lenders get paid by charging you a premium over their base cost, which is determined by all the factors mentioned above. It is that simple. If your credit and property profile are the same, then the difference in rates and costs is the lender's premium.

2. Likelihood of Closing / Leaving you at the Altar
This is something that is REALLY important that is really difficult to explain to my clients, but said simply, everything has a price. If you want good service, you are going to have to pay for that. Conversely, if you find a lender who offers you a crazy low rate, there is a very real possibility that they might hang you out to dry when it comes to closing. We've seen it happen. Is 12.5 bps worth risking your earnest money or losing a house over? The lenders who are active on this forum might not offer you the absolute cheapest rate, but they do offer their word and reputation that they will do whatever is in their power to help you close.

3. Escrow
When you get a loan, your lender would prefer that you escrow property taxes and insurance with them such that they pay those items for you. Depending on your LTV, escrow may be required or optional (some lenders require more than 20% equity to waive escrows, others will go as low as 10% to waive them). No matter what your LTV ratio is, if you waive escrows, you will incur higher loan pricing to account for the extra risk the lender perceives that they are taking on (if for some reason you don't pay those). If you escrow at closing, expect at least one year of insurance to be paid up front in addition to at least as many months of property taxes and insurance escrowed as there are months remaining in the year. Pro tip--if you obtain a loan with escrows with more than 20% down, and later decide that you want to waive escrows and pay for property taxes and insurance yourself, the lender is required to allow you to do this.

4. Refinancing
Refinancing can make sense depending on how much money you will spend to refinance, how much money you will save each month going forward, and how many months it will take you to recoup that cost (versus how long you believe you will own the property into the future).

5. History of Mortgage Rates
Mortgage rates have never been lower than they are as of this post, but nobody knows what they will look like in the future. Right now Mortgage rates in some areas of Europe are negative, so over time, your balance decreases more than the principal payments you make. Could this happen in the US? Below is a chart published by the US Fed that shows the history of mortgage rates since 1971.



6. My mortgage was sold after closing!
Unless your lender tells you otherwise, or you go directly to a bank that services their own loans, you should expect that this will happen. Your loan is a product that can be resold and it is not a reflection on you, so don't feel bad about it if it happens. Some servicers are better than others, so factor this when you are picking a lender.

7. Junk mail you will get after closing
Throw it away. Nothing you get in the mail after closing from third parties is something that you need. It's a scam. Most of the time I take their page they mail you to complete, write them a nice note, and mail it back to them so that they incur the pre-paid postage cost.


G. Glossary / Abbreviations

APRTotal cost of your loan inclusive of base rate and closing costs/fees.

ARMAdjustable Rate Mortgage

BPSIndustry term pronounced "Bips" that stands for "Basis Points". One basis point is equal to 1/100th of a percent. For example, 50 bps equals 0.50%. Finally, rates are typically priced in eighths, or increments of 12.5 bps.

CD - Closing Disclosure

CFPBConsumer Financial Protection Bureau

CreditFee a lender pays you to agree to increase your rate from the Par rate.

CTC - Clear to Close

Dodd FrankNeeds to be repealed for a lot of reasons.

DTIDebt to Income Ratio. Calculated as your total monthly expenses divided by your total gross income. Should be less than or equal to 45%.

The FedFederal Reserve Bank of the US is NOT owned or managed by the US Federal Government. It's a privately-controlled central bank that helps set monetary policy for the United States.

LTCLoan to Cost

LTVLoan to Value

MTGMortgage

Mortgage BrokerActs as an intermediary to connect buyers with the final lender. They can often get you cheaper debt than you could get yourself with the same lender (mortgage brokers fee included).

PMIPrivate Mortgage Insurance. Can be paid monthly or up front as a lump sum.

PointsFee you pay to the lender to decrease your rate from Par to a lower rate.

UW - Underwriting or Underwriter

Yield Curve A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity.



Sponsor Message: We Split Commissions. Full Service Agents in Austin, Bryan-College Station, Dallas-Fort Worth, Houston, & San Antonio. Red Pear Realty Also, contributor at Houstoning.
wessimo
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Great post.
HYC_AG
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Awesome information!
Mortgage Man aka 84CTSQ5
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Great job RedPear! Remember Ags that if you have any mortgage related questions or want any help with a mortgage, feel free to pm me. NMLS1969754
jja79
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Mostly good information.

You can get a conventional loan with less than 5% down.

Loans with 5% down don't necessarily get the highest interest rate since they're insured.

Down payments less than 20% can avoid mortgage insurance with combination financing to keep the LTV at 80% with a higher CLTV.

Unmarried borrowers don't get higher rates than married borrowers as that would violate the familial status of Fair Lending laws.

ARM loans don't have adjusters built in to most often increase 2% at the first adjustment. They generally have a base rate plus CMT or another index.
texas.aggie.2010
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" At 20% equity, you are not required to pay PMI, but you'll usually get a worse interest rate than if you put down 10% but were required to pay PMI". Can you expound on this statement?

I'm looking at putting down 20% to avoid PMI. If the above were true, why wouldn't I just put 10% down , close, then on day 4 of ownership pay the other 10% early to stop pmi?
jja79
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You didn't ask me but that isn't really accurate information. Regarding making a reduction day 4 find out what the required period is on maintaining mortgage insurance on your particular loan. It's probably not 4 days.
Red Pear Realty
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texas.aggie.2010 said:

" At 20% equity, you are not required to pay PMI, but you'll usually get a worse interest rate than if you put down 10% but were required to pay PMI". Can you expound on this statement?

I'm looking at putting down 20% to avoid PMI. If the above were true, why wouldn't I just put 10% down , close, then on day 4 of ownership pay the other 10% early to stop pmi?


Very possible that different lenders have different takes on risk, and therefore pricing, but I've seen this a couple of times this year, including with a family member. The way it was explained to me by the lender is that PMI takes the risk off the table to the lender, so they would rather you do a deal at 10% down with PMI than with 20% down. And I agree, you should know the terms of your loan and PMI. That's really the whole point of this post, to get information (the whole picture) to the consumer in one place.
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Jay@AgsReward.com
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It is not lender to lender. Fannie/Freddie have what are called loan level pricing adjustments. and they are published right here: https://singlefamily.fanniemae.com/media/9391/display

Red Pear Realty
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Jay@AgsReward.com said:

It is not lender to lender. Fannie/Freddie have what are called loan level pricing adjustments. and they are published right here: https://singlefamily.fanniemae.com/media/9391/display




That's awesome info. Thanks for sharing.
Sponsor Message: We Split Commissions. Full Service Agents in Austin, Bryan-College Station, Dallas-Fort Worth, Houston, & San Antonio. Red Pear Realty Also, contributor at Houstoning.
SteveBott
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I have a few quibbles with the OP but still a good summation. JJ hit a few of mine already. Jay linked the most common adjusters but there is also on occasion "investor overlays" which the end buyer of the loan adds incentives or penalties on top of Fannie.

Priced a loan for Va last week with 669 credit. One lender wanted basically 2.5 and the next lender on the same file was 2.25. So a credit overlay was in place for the first lender
texAZtea
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Non-hypothetical question:

Lets say I'm moving in the next 2 months. I have a place to stay for a couple months so I'm not in a rush to move until April/May.

I see a house I like and I've reached out to some lenders but they all want to do a hard pull. I'm hesitant because I don't want to hurt my credit. But I also want this house.

Should I go ahead and let the lenders do a hard pull to get pre-approved? How long does "pre-approval" last?
Red Pear Realty
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texAZtea said:

Non-hypothetical question:

Lets say I'm moving in the next 2 months. I have a place to stay for a couple months so I'm not in a rush to move until April/May.

I see a house I like and I've reached out to some lenders but they all want to do a hard pull. I'm hesitant because I don't want to hurt my credit. But I also want this house.

Should I go ahead and let the lenders do a hard pull to get pre-approved? How long does "pre-approval" last?


Lenders can't give you actual rates and terms unless you allow them to run your credit. But the good news is that as long as multiple lenders all pull your credit within a 14 day period, then all of those pulls only count as one ding on your credit report. And I believe that a credit pull is good for 120 days, at which point, if you haven't closed, then they would need to re-pull.
Sponsor Message: We Split Commissions. Full Service Agents in Austin, Bryan-College Station, Dallas-Fort Worth, Houston, & San Antonio. Red Pear Realty Also, contributor at Houstoning.
Jay@AgsReward.com
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A hard pull is an overrated obstacle. if a lender tells you not to have any one else pull your credit because it will lower your score run away. They are trying to keep you from shopping rates/terms, and I wonder why that would be? You can have as many pulls in a 45 day period as you want: CFPB link Credit reports are generally good for 90 days.

I give rate quotes all the time just using a score given to me by the borrower without pulling credit, but with the understanding the rate and terms can change with a lower then expected score (and maybe get better if score is higher then expected) but you would need a full application which would include a credit pull to get a pre-approval letter and rate lock etc.
jja79
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^^^^

What Jay said. Most borrowers have a legitimate idea what their score is if they've talked to one lender so quoting isn't that difficult. Always be suspicious of a lender who "warns" you about having another credit report run. People with good credit aren't being punished for prudently considering their mortgage options.
Red Pear Realty
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This article, from 2019, says that the new FICO model allows for 45 days, but if the lender uses the old model, it remains at 14 days. Is anyone still using the old model that would limit to 14 or is that a thing of the past?

https://loans.usnews.com/articles/how-to-shop-for-a-mortgage-without-hurting-your-credit-score
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SteveBott
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No. It's 14 days. There are eight scoring models just from the three main bureau's E1-E8. We use E2 the same system since I got into the business in 2002.

There is some discussion at the Fannie level to update but no decision yet
Jay@AgsReward.com
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FICO is 45 days for Transunion and Equifax, and 14 days for Experian for the Fannie required Equifax Beacon 5.0 and Transunion Classic 4. Experian FICO is 14 days but that does not generally matter as we use the middle score of the three. https://www.equifax.com/personal/education/credit/score/difference-between-fico-scores-vantagescore/

https://www.scotsmanguide.com/browse/content/borrowers-shouldnt-fear-credit-inquiries

https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-1-Credit-Scores/1032996841/B3-5-1-01-General-Requirements-for-Credit-Scores-08-05-2020.htm
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