Qualifying For A Home Loan
When applying for a loan, the lender will evaluate all parts of your loan application.
Having strengths in some areas can help with weaknesses in other areas. Discussed
below are some of the items lenders are going to be focusing on when qualifying you
for a home loan.
Credit History FICO Score:
Your credit score is going to be a big factor in approving you for a home loan. Your
credit report will give the lender a good idea about whether or not you pay your
bills on time. A FICO score is a credit score developed by Fair Issac & Co. FICO scores are reported by each of the three major credit agencies: Experian,
Equifax, and Trans-Union. The lenders usually take the middle of the three scores
for the loan application.
Your payment history, length of credit
history, the amount you owe, types of credit used, and
new credit all have weight on your credit score.
A low credit score is going to negatively affect your chances of qualifying, as
well as raising the interest rate you receive. It is a good idea to check your credit history in advance to correct any errors
that might unknowingly exist.
Employment History and Income:
Lenders like to see job stability and optimally that you have been
with the same employer for at least two continuous years. Working for the same employer for at
least two years shows good employment stability and steady income. Depending
on the level of income verification, pay stubs, W-2s, bank statements, and other items
showing incomes and bank balances may be required.
For the self-employed, there are alternative documentation possibilities. This may
include bank statements and up to three years of tax returns for calculating your income.
Debt-To-Income Ratio:
The Debt-To-Income (DTI) ratio tells the lender how much of your gross monthly income goes to your
monthly debt. The more debt you have lowers your chances of qualifying for a mortgage.
The DTI ratio may also be used by lenders to determine how much to lend you.
Typically, you don't want your monthly recurring debt to be more than 36% of your gross monthly
income. Recurring debt should include your mortgage payment(s), credit card payments, car loans, student loans, and any other monthly obligations. Having a high DTI will cause
the lender to see you as riskier, leading to increased interest rates and a smaller size of loan you can qualify for.
Loan-To-Value:
The more money you put down, the better your interest rate is going to be. If your
loan-to-value is more than 80% of the value of the home, you will be required to
pay private mortgage insurance (PMI) which protects the lender in case of default.
The other 20% can come from a second mortgage loan or in some cases grants or gifts.
Borrowers with a smaller down payment are viewed as riskier.
Lenders are also going to want to know where the
down payment came from. The lender is more confident when the money comes from your
own personal savings rather than a gift or other sources. If the down
payment is a gift, the lenders will also want the source of the gift to be verified because
the lender wants to know the gift doesn't have to be repaid. Generally, borrowing
money for a down payment is not allowed.
Reserves:
Having some reserves in the bank after closing may be a requirement by the lender
in case the borrower defaults on the loan. The lender may want to see 2-3 months of mortgage payments.
Reserves can be money in your bank account, or an IRA and 401(k), which can also
be seen as cash reserves. Different lenders will have different requirements.