October 26, 2016
If you plan to borrow money, it’s a good idea to begin by knowing your credit score. And despite what your friends might tell you, this is only a starting point.
Mortgage lenders often want to know more about your finances than how reliably you make credit card and car loan payments. Those are important factors, but there is more to the mortgage formula than that.
Houses are big-ticket items — they’re the biggest purchase that most people will ever make. It typically takes 10–30 years to repay a home mortgage. Due to the size of the loan and the decades-long repayment schedule, lenders want to know a lot about the borrower’s financial situation.
You should know up front that many lenders aren’t interested in servicing your mortgage for the duration, but instead plan to sell the loan to another financial institution. The value of the debt typically depends on the financial strength of the borrower, which is you.
Standards have become tougher in recent years. You might remember that the Great Recession was largely the result of bad real estate loans. During the years leading up to 2007, housing prices increased rapidly, partly as a result of lenders having offered unconventional mortgages to people with poor credit.
Those subprime loans often started with low payments that ballooned after a few years. Unfortunately, many buyers’ incomes didn’t increase when their mortgage payments did, resulting in enough defaults and foreclosures to dramatically shake the entire U.S. banking system.
Since then, lenders have tightened their rules on who can borrow and how much money they can borrow.
If you’re applying for a mortgage, it’s important to know how much home you can afford. Lenders use different criteria to qualify mortgage borrowers. They might start with your credit score, but they will also have questions about your income, your investments and even your frequency of relocation.
According to the Mortgage Bankers Association, lenders reviewed 11.1 million primary-mortgage applications in 2015 and issued 6.8 million loans. That is about a 68% approval rate, which means almost one-third of the mortgage applications faced rejection.
To ensure that you get approved, you should review your finances with a lender or housing counselor before you start house hunting. Many lenders will pre-qualify you for a mortgage of a certain size, which will help you decide how much you can afford to pay.
Here are some things that lenders will consider as they assess how much house you can afford:
Value of the Asset
If you default on your car loan or mortgage, the lender will normally repossess or foreclose on the asset to recoup the amount that you owed. But if the asset isn’t worth as much as the amount loaned, the lender loses, and lenders don’t like to lose. They want to assess the value through an appraisal or, in the case of a car, the book value of the vehicle.
Your Income and Debt
Do you earn enough to cover the payments? You might think so, but lenders often rely on a formula called the debt-to-income ratio. They want to establish that your debt is no more than a certain percentage of your income – in most cases, no greater than 43 percent. To calculate your debt to income ratio, divide your total monthly debt by your monthly income and multiply by 100. To verify income, lenders might ask to see pay stubs, bank statements, and even income tax returns. They also might want information on money you owe.
Your Savings and Investments
How much money have you saved or invested? How long have you had that money? Lenders might want copies of bank statements, investment statements, and retirement account statements, both current and from two or three years back. This factor is often important for retirees.
A lender will want to know how long you have worked for your current employer, since this may give them a glimpse into your future income and your ability to keep paying a mortgage.
Do you move often or do you tend to stay in one place for many years? Do you always pay your mortgage or rent on time? Lenders often favor stability and consistency.
Paying Your Bills
Does your recent payment history show a person who conscientiously pays on time? Lenders are usually most concerned with how you’ve performed in the past few years, and your payment history is a big factor in your credit score. A previous mortgage default can be a huge strike against you, and you often can’t qualify for a mortgage for years after a foreclosure or a short sale.
Making a Down Payment
If you can immediately contribute a chunk of money as a down payment, then naturally, your total loan amount will shrink. A smaller loan means lower payments, which improves the odds that you will qualify for the loan.
Social Media Behavior
Yes, the things you post publicly on Facebook and other sites might have mortgage-related repercussions. Data banks may look at online behavior for hints about how you handle money.
The three large credit rating agencies use myriad data to assign your credit score, which is typically a number between 300 and 850. The agencies analyze how faithfully you repay credit cards, among other financial activities. Your credit score is always changing – rising when you pay debts meticulously, falling when you fail to pay debts on time, run up big balances or use too many different credit cards. It pays to learn what factors matter when you are trying to improve your credit score.
- LaPonsie, M. (2016, March 17) Beyond Credit Scores: 7 Factors That Affect a Loan Application. Retrieved from: http://money.usnews.com/money/personal-finance/articles/2016-03-17/beyond-credit-scores-7-factors-that-affect-a-loan-application
- (2016, July 16) Factors that Affect Loan Application. Retrieved from: http://www.yourprovenance.com/blog/2016/07/15/factors-that-affect-loan-application/
- (2016, June 1) Factors that Affect Your Loan Application and Approval. Retrieved from: http://financialrescuellc.com/factors-that-affect-your-loan-application-and-approval/
- ND. Ten Key Factors When Applying for a Mortgage Loan. Retrieved from: https://www.allbusiness.com/ten-key-factors-when-applying-for-a-mortgage-loan-3409-1.html