Babies bring many surprises, but here's one you might not expect: New parents can find it hard, if not impossible, to take out new loans if they are still on leave from work. That means moms on maternity leave can get denied when they apply for mortgages or, soon, even new credit cards. And because parenthood so often coincides with big purchases—TheBump.com reports that 45 percent of expectant moms plan to move to a new home before their child’s second birthday—this credit clampdown can throw some serious rain on a new parent's parade.
[In Pictures: 10 Smart Ways to Improve Your Budget.]
"We tell customers, 'Don't quit or change jobs, don't open new accounts, don't go out on leave'—all of that could derail a transaction," says LendingTree's Senior Vice President of Mortgage Services Chad Smith. New parents who are paid at a reduced rate while on leave can only be qualified based on that reduced rate, he explains. Likewise, a new parent on unpaid leave—the only option available to many parents in this country—are essentially treated by many lenders as if they are unemployed. That makes it hard, if not impossible, to take out a mortgage.
While being on leave from work would have held up most traditional loans even before the subprime mortgage crisis, lenders have since tightened their rules even more. Another recent change places an additional obstacle in the path of new parents seeking credit: Starting in October, the Federal Reserve requires that credit card issuers consider individual income and not household income when evaluating credit card applications. That means stay-at-home moms and dads who are not earning income could suddenly find themselves unable to obtain new credit cards. Taken together, these credit restrictions add extra financial pressure on new parents, just as they are experiencing one of the biggest stresses (and joys) of their lives.
The reason for these policies is pretty simple: Lenders don't want to approve loans for borrowers who can't afford them, and if you're not currently earning any income—or if you're earning a lot less than usual because you're on leave—it looks like you can't afford the loan. "We care very much that the loans we make are affordable. If we put you in harm's way, then we're in harm's way," says Bill Higgins, chief lending officer for ING Direct, referring to the fact that the lender keeps the loans it makes instead of selling them to third parties.
Likewise, the Fed announced that its rule change for the credit card industry is designed "to protect consumers from incurring unaffordable levels of credit card debt." And while credit experts have pointed out that stay-at-home spouses can use secured lines of credit or become an authorized user on their working spouse's card, neither of those solutions quite allow for the independence that comes with owning one's own piece of plastic.
As for mortgages, the specific rules vary by lender. ING Direct says it treats each loan application individually and potential borrowers on maternity leave are likely to have a "candid conversation" with the bank about their plans and anticipated future earnings. "Our presumption is that [mothers on maternity leave] will return to work...you'll probably have had those conversations about 'can we afford this,' and 'what if I don't go back to work.' We give customers credit for doing that hard work," says Higgins. At the same time, he adds, "We want to create loans that will be successful for the customer," so in some cases, that means talking specifically about their return-to-work plans.
At Bank of America, applicants on maternity leave need not return to work already for loan approval, but the lender does require written proof of their intent to return to work and in some cases, will also request a letter from the employer confirming the expected return date and wage.
So, what can new parents do to overcome their credit odds? Here are seven strategies:
1. Borrow from a non-traditional source. LendingTree's Smith says that in some cases, home sellers themselves are willing to work with the buyer on financing, including carrying the mortgage until the buyer returns to work. Another option is looking to family members who are willing lend the money or co-sign the mortgage.
When it comes to credit cards, Credit.com's Farnoosh Torabi recommends that stay-at-home parents consider secured cards, which are loaded with your own money and not dependent on income checks, or become an authorized user on a spouse's card. "They'll get their own credit card to the account and build credit history along the way," she says.
2. Buy less house than you can afford. If the new dad returned to work but the new mom is still on unpaid maternity leave, lenders might only consider the dad's income – and that might not be such a bad thing. Considering the fact that babies come with a lot of extra expenses, from child care to diapers, buyers who are also new parents might want to take out a much smaller loan they can they afford anyway. Relying on only one income for the mortgage is one way to do that.
3. Pay off debt ahead of time. Unloading monthly debt payments, whether for student loans, car loans, or credit cards, can make a borrower more appealing to lenders, and also make it easier to manage new monthly mortgage payments. So whether you're doing it to help convince a lender to take a chance on you or you want to make your bills easier on your own budget, it's always a good idea to become as debt-free as possible before buying a house.
4. Take one major life event at a time. Half of new parents might move into a new home before their baby's second birthday, but that doesn't mean you have to. "Going from no children to a child is an awesome, overwhelming event, and then when you throw in a house on top of it, it tends to be harder when you do it all of once," says ING Direct's Higgins, himself a father of eight. That's why he recommends spacing things out so you don't end up closing on a house days or weeks after giving birth.
Similarly, Torabi says that if new parents anticipate going on parental leave and don't yet have any existing credit cards, they can apply for one before their babies arrive. "It may be smart to go to their local credit union and apply for a card with a low interest rate and high limit, for emergencies," she adds.
5. Get your paperwork in order. "The more prepared they are with all their documentation, asset statements, and understanding their credit situation, the easier it is to close the transaction," says Smith. Even seemingly small details like selecting homeowners' insurance can help prevent any last-minute hiccups.
6. Shop around. Lenders, including the ones mentioned above, vary in how they treat borrowers on temporary leave from work. Shopping around to find the lender who will give you the best deal for your situation is always a good idea.
7. Improve your credit score. Experian's Rod Griffin recommends pulling your credit report at least six months before applying for a mortgage to give yourself time to get rid of any errors. (Visit annualcreditreport.com for your free credit report, which consumers can get once a year.) You might also want to spend some time getting your income and asset statements organized; while neither go into a credit report, lenders will ask for them as part of the loan application process.
With your credit in order, you can focus on enjoying your new bundle of joy.
Kimberly Palmer (@alphaconsumer) is the author of the new book Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back. She experienced many of these challenges first-hand when trying to buy a house on maternity leave.