Qualifying for a
Mortgage
A basic truth: A
mortgage loan holds your house and land as collateral; it's not pound of flesh,
but the loss can seem just as life-threatening.
In most cases, a
lender does not really want to end up with your house. They want you to succeed
and make those monthly payments that make the world (or at least the U.S.
world) go 'round. So when you apply for a loan, the lender will scrutinize your
financial situation to make sure you are worth the risk.
You need to get your
paperwork in order before you find a lender, but first you should understand
the basic facts.
- Down
payment. Traditionally,
lenders like a down payment that is 20 percent of the value of the home.
However, there are many types of mortgages that require less. Beware, though:
If you are putting less down, your lender will scrutinize you even more. Why?
Because the less you have invested in the home, the less you have to lose by
just walking away from the loan. If you cannot put 20 percent down, your lender
will require private mortgage insurance (PMI) to protect himself from losses.
(However, if you can only afford, for example, 5 percent down, but have good
credit, you can still get a loan, and even avoid paying PMI.
- LTV. Lenders look at the Loan to Value (LTV)
when underwriting the loan. Divide your loan amount by the home's appraised
value to come up with the LTV. For example, if your loan is $70,000, and the
home you are buying is appraised at $100,000, your LTV is 70%. The 30 percent
down payment makes that a fairly low LTV. But even if your LTV is 95 percent
you can still get a loan, most likely for a higher interest rate.
- Debt
ratios. There are two
debt-to-income ratios that you need to consider. First, look at your housing
ratio (sometimes called the "front-end ratio"); this is your
anticipated monthly house payment plus other costs of home ownership (e.g.,
condo fees, etc.). Divide that amount by your gross monthly income. That gives
you one part of what you need. The other is the debt ratio (or "back-end
ratio"). Take all your monthly installment or revolving debt (e.g., credit
cards, student loans, alimony, child support) in addition to your housing
expenses. Divide that by your gross income as well. Now you have your debt
ratios: Generally, it should be no more than 28 percent of your gross monthly
income for the front ratio, and 36 percent for the back, but the guidelines
vary widely. A high income borrower might be able to have ratios closer to 40
percent and 50 percent.
- Credit
report A lender will
run a credit report on you; this record of your credit history will result in a
score. Your lender will probably look at three credit scoring models, they will
use the median score of the three for qualifying purposes. The higher the
score, the better the chance the borrower will pay off the loan. What's a good
score? Well, FICO (acronym for Fair Isaac Corporation, the company that
invented the model) is usually the standard; scores range from 350-850. FICO's
median score is 723, and 680 and over is generally the minimum score for
getting "A" credit loans. Lenders treat the scores in different ways,
but in general the higher the score, the better interest rate you'll be offered.
- Automated
Underwriting System. The days when a
lender would sit down with you to go over your loan are over. Today you can
find out if you qualify for a loan quickly via an automated underwriting
system, a software program that looks at things like your credit score and debt
ratios. Most lenders use an AUS to pre-approve a borrower. You still need to
provide some information, but the system takes your word for most of it. Later
on, you'll have to provide more proof that what you gave the AUS is correct.
To see if you'd qualify for a mortgage submit
an anonymous loan request on Property
Genius Marketplace or use our Affordability
Calculator.