What Happens When Your Credit Score Drops During Underwriting?

Credit scores serve as a numerical representation of an individual’s creditworthiness, ranging typically from 300 to 850. These scores are highly influential in financial transactions, especially when seeking substantial loans such as mortgages or car loans, as they indicate a borrower’s likelihood of repaying debt on time. Lenders rely on these scores to assess risk and determine eligibility for various financial products. Underwriting is a thorough process undertaken by lenders to evaluate a loan application comprehensively, including a detailed review of an applicant’s financial profile, ensuring they meet the specific requirements for the requested loan. A drop in a credit score during this underwriting phase can significantly concern applicants, potentially affecting the loan’s approval or its terms.

Underwriting and Credit Monitoring

Underwriting functions as the lender’s risk assessment process, where financial institutions meticulously review a borrower’s financial background and credit history to determine loan eligibility. This comprehensive review ensures the applicant meets the specific criteria for the loan requested, evaluating factors like income, assets, and debt. An underwriter assesses the borrower’s credit report, income verification documents, and asset statements to gauge their ability to repay the loan and the overall risk involved. This detailed scrutiny helps lenders make informed decisions about the loan amount and interest rate.

Lenders typically conduct multiple credit checks throughout the underwriting period, not solely at the initial application. An initial credit pull helps determine pre-approval and initial eligibility, while a subsequent “soft pull” or credit refresh is common just before closing. This second check, usually a soft inquiry that does not impact the score, helps confirm that a borrower’s financial situation has not significantly changed and that they still meet the eligibility requirements. It allows lenders to identify any new credit accounts, inquiries, or significant changes to balances that could alter the risk profile.

A credit score can fluctuate or drop during this period for several reasons. New credit inquiries, increases in credit card balances (leading to higher credit utilization rates), or a single late payment can significantly impact a score. Payment history is the most influential factor in credit scoring. Opening new accounts can also affect the score by increasing overall debt and potentially lowering the average age of accounts. Errors or fraudulent activity on a credit report can also lead to an unexpected score decrease until disputed and resolved.

Lender Actions After a Credit Score Drop

When a borrower’s credit score drops during underwriting, lenders will re-evaluate the loan application to assess the new risk profile. A small fluctuation does not affect approval or interest rates. However, a significant drop can lead to more severe consequences, potentially delaying the closing process or even resulting in loan denial. Lenders are primarily concerned that the borrower’s financial stability and ability to repay the loan may have deteriorated.

One potential action is the re-evaluation of loan terms. If the score drop moves the borrower into a lower credit tier, the lender might impose a higher interest rate on the loan. This is because a lower credit score signals increased risk, and lenders adjust pricing to compensate for that risk. Additionally, the lender might require a higher down payment or an increase in the loan’s fees to offset the perceived higher risk. These adjustments aim to ensure the loan remains profitable and secure for the lender.

Lenders may also request additional documentation or explanations from the borrower to understand the reason for the score drop. This could involve asking for updated bank statements or proof of resolution for any new derogatory marks. The underwriter needs to verify that the change does not indicate a fundamental shift in the borrower’s financial capacity or willingness to repay. If the explanation is unsatisfactory or the issues persist, the lender might place additional conditions on the loan.

In some cases, a significant credit score drop could lead to the loan being converted to a different loan type. The lender might suggest options like an FHA (Federal Housing Administration) loan, which may have more flexible credit score requirements but different terms or mortgage insurance premiums. This aims to keep the loan viable, albeit under different conditions.

Ultimately, if the credit score drops below the minimum requirement for the specific loan program, or if the new financial situation significantly increases the debt-to-income (DTI) ratio beyond acceptable limits, the loan application could be denied. This can occur if the changes indicate that the borrower can no longer comfortably afford the monthly payments. While a denial is a possibility, it is not always the immediate outcome for minor score fluctuations.

Borrower Steps When a Credit Score Drops

If a borrower discovers their credit score has dropped during underwriting, or is informed by their lender, immediate and proactive steps are necessary. The first action involves promptly checking their credit reports from all three major bureaus—Experian, TransUnion, and Equifax—for inaccuracies. Free annual credit reports are available, and reviewing them can help identify errors that could be impacting the score.

Should errors be found, disputing them with the credit bureaus is an important next step. This process involves submitting a formal dispute to the respective credit bureau, which then investigates the claim. Correcting inaccuracies can potentially restore points to a credit score and improve the overall financial profile. It is important to also inform the lender about any ongoing disputes and their potential positive impact on the score.

Communicating proactively and transparently with the lender is also important. Borrowers should be upfront about the credit score change and its cause, providing explanations or documentation for any legitimate reasons behind the drop. Lenders may be more willing to work with a borrower who communicates openly and provides a clear understanding of the situation, potentially offering alternative solutions or requesting a letter of explanation.

During the underwriting period, and especially after a score drop, borrowers should strictly avoid any new credit activity. This includes refraining from applying for new credit cards, taking out additional loans, or making large purchases on existing credit cards. Such actions can lead to further hard inquiries, increase debt-to-income ratios, or raise credit utilization, causing further score depreciation and jeopardizing the loan approval. Maintaining existing credit accounts in good standing and keeping credit card balances low is also important to prevent further score reductions.

In situations where a significant drop occurs and the loan is at risk, exploring alternative loan options with the lender might be necessary. This could involve discussing programs with more flexible credit requirements. If credit issues are substantial, a short delay in closing might be considered to allow time for score improvement through debt reduction or error correction, potentially leading to better terms.