5 Things Mortgage Lenders Look For
Published July 1, 2014 | Updated July 15, 2014
Applying for a Mortgage
No matter whether you're applying for a credit card, an auto loan, or a home mortgage, your FICO or credit score, job history, income, and debt will affect how much you can borrow, what rate of interest you pay, and whether or not you get the loan.
Generally speaking, mortgage lenders consider the following when decisioning loans:
- Income Stability: This can be more than your salary. If you have other verifiable income and financial assets with at least a two-year history, these will work to your advantage. Examples include investment income, social security, disability, commissions, royalties, and alimony payments.
- Debt-to-Income Ratio: Lenders traditionally prefer that your combined debt and housing expense not exceed 36% of your monthly pre-tax income. Generally that breaks down as 28% for housing expense and 8% for debt. Housing expenses include principal, interest, taxes and insurance (PITI), and can include condominium maintenance fees and home owners' association fees. Items considered in your debt calculation include credit card balances, installment loans (such as auto loans), and student loans. It's a good idea to reduce your debt as much as possible before applying for a mortgage.
- Loan-to-Value Ratio: A loan-to-value (LTV) ratio is the amount of your loan proportional to the value of your property. A lender's ideal LTV is 80%, which means you're putting 20% down and borrowing 80% of the property's value. Smaller down payments usually trigger penalties such as mandatory PITI and the lender taking, holding, and paying your annual insurance and taxes rather than you managing those funds. If coming up with a down payment is a challenge, investigate loan programs designed to help you buy a home without a lot of cash, or use gifted or borrowed funds.
- Property Appraisal: All lenders require a professional financial assessment of your property by a licensed appraiser to ensure the market value equates to the loan amount. A lender needs to know that the borrower's collateral, which includes both the property and the down payment, will be enough to recover their investment in case the borrower defaults on loan repayment. An appraisal also helps you know you're not offering too much for the property.
- Credit History: It's a good idea to check your own credit report to correct any errors. Past credit problems don't have to be an obstacle. If you can reasonably explain (and verify) hiccups in your payment history, most lenders will listen. If your FICO score is below 620 you will be considered a higher risk loan candidate and should expect to pay at least two percent more in interest on a loan than a prime borrower taking out the same loan.
Have Your Documents Ready
Lenders will want to see salary history and two or more years of tax returns. If you have credit issues, be ready to explain them. Lenders don't make money when they don't make loans, but they need to show they are making prudent loans. Unless potential borrowers have absolutely no financial credibility, they should never assume that subprime credit means he or she has no bargaining power. Have your realtor, your lender, or a mortgage broker help you explore all of your options and get pre-approved before you start shopping.