Applying for a Mortgage
When it comes to borrowing money – whether it’s applying for a credit card, an auto loan, or a home mortgage – your FICO or credit score, job history, income, and debt load will affect how much you can borrow, what interest rate you pay, and whether or not you even get the loan in the first place.
So that you know exactly what a mortgage lender is going to be looking at when you ask them for six figures worth of credit, we’ve compiled this quick guide. These are the five key points upon which they will focus:
- 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 percent of your monthly pre-tax income. Generally, that breaks down as 28 percent for housing expense and 8 percent for debt. Housing expenses include principal, interest, taxes and insurance (known as 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 percent, which means you're putting 20 percent down and borrowing 80 percent 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 consider using gifted or borrowed funds, if those are available to you.
- 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 credit report to correct any errors, if needed. Past credit problems don't have to be an obstacle. If you can reasonably explain (and verify) problems 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. The higher your score, the lower the interest rate on your 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. It’s also a good idea to get pre-approved by Amplify Credit Union before you start shopping.