Are you getting ready to change homes or buy your first home? If so, you’ll likely need a mortgage loan to do it. Many Americans are ill-informed when it comes to home loans. Let’s walk you through some simple steps to help you understand the process and improve your chances of approval.
Averages for for the median duration of homeownership vary based on geographical location. However, the nationwide average was around 13 years in 2018. So, it might have been a bit since you last applied for a mortgage. This article will offer you a current perspective on mortgage lending.
Of course, this may be your first time as a buyer. After all, millions of Americans rent for years as they financially prepare themselves for homeownership. Again, the article will help you understand the process and what it takes for success.
Whether upsizing, downsizing, changing areas for personal reasons, or moving from a renter to a homeowner, it’s important to understand the current ins and outs of a mortgage approval.
Prior to the last subprime mortgage crisis, approval was almost guaranteed just by applying. At the time, little attention was being paid to any indicators as to a particular applicant’s ability to pay. As a result, foreclosures exploded in the sluggish economy.
Today, lenders have had to tighten their belts. While lenders are still eager to help you buy a home, they’re much more prudent in restrictions, realistic loan amounts, and applicant vetting.
Tips To Up Your Chances Of Getting Approved
1. Understand Your Credit Score
Never apply for any loan without knowing where your credit stands. Did you know that your credit score drops several points each time your credit is pulled? To keep it as high as possible, you want to ensure it’s pulled as few times as possible during the mortgage application process.
Your credit score is basically like a GPA concerning how well you handle your debts. Student loans, vehicle loans, credit cards, and other types of revolving debt are reported by the creditors to the credit bureaus with notations on your standing. Other credit score factors include:
- Debt total
- Number of open accounts and their standings
- Types of debt
- Credit utilization
- Timeline of credit history
If you have negative marks in any of the above areas, your credit score may be below 660. Scores below that number usually don’t qualify for a traditional mortgage loan. If they do, it’s usually attached to very unfriendly terms, such as astronomical interest rates, high down payments, and so forth.
Know your score. Take steps to improve it. Monitor your score for progress. Once above 660, apply for a mortgage pre-approval.
Where can you get your credit score?
Most major credit card companies will offer customers free credit scores. Credit Karma offers scores for TransUnion and Equifax, and it offers helpful tips on how to get your credit back into good shape. AnnualCreditReport.com. offers one free copy of from all three major reporting agencies (TransUnion, Equifax, and Experian) annually.
2. Correct Credit Report Errors
As you check and monitor your credit, you may notice reports that aren’t correct. Such errors can drastically impact your credit score. Credit Karma and AnnualCreditReport.com offer detailed instructions on how to challenge errors. Once initiated, the credit reporting agencies have 30 days to review the claim and determine if your reported error is either valid or removable.
3. Get All Your Documents Organized
Lenders require a great deal of financial paperwork during the mortgage process. You’ll want to have the following documents ready:
- W-2 forms for this year and last year
- Income taxes for this year and last year
- Paycheck stubs for this month and last month
- Business checking account records for this month and last month if self-employed
- Balance sheet if self-employed
- Checking and saving account statements for this month and last month
In getting the above documents ready, be prepared to answer any questions related to unusual withdrawal or deposits, gaps in employment history, late payments on debts, bank overdrafts, and so forth during the underwriting process.
4. What’s Your DTI?
Debt-to-income, or DTI, is the the ratio of your debt in comparison to your income. It’s a major factor in any loan approval process. It’s what the lender uses to determine if you are financially capable of paying a particular loan note each month. Examine your DTI before you apply for a mortgage.
How do I figure DTI?
Begin by looking at your tax return or paycheck stubs to determine your annual gross income, which is the amount before taxes, retirement, and insurance are withheld.
Add up all of your set revolving monthly debts – childcare expenses, loan notes, rent/mortgage, child support, credit card payments, student loan notes, and so forth. Cost of living expenses that fluctuate, such as grocery bills, utilities, medical expanses, and so forth, should NOT be included.
Divide your total monthly debt by your gross income. The resulting number is your DTI percentage. If your income is $69,000 and your monthly expenses are 1,200, then your DTI is at 21%.
Your DTI goal should ideally be less than 35%, which signals to lenders that you have plenty of money left over each month for savings, emergencies, and discretionary spending. From 36%-49%, lenders view you as risky because you’re cutting it close each month and have little funds for unforeseen expenses. If your DTI is over 50%, you’ll likely have limited borrowing options, if any.
Don’t worry if your DTI is higher. It simply means that you’ll need to work on paying off some of your existing debts before you apply for your mortgage.
5. Freeze Your Spending
If you’ll be applying for a mortgage within the next six months, don’t make any major purchases. Why?
The lender will look to your savings and checking account balances as part of the pre-approval and final approval processes. They’re looking for balances and spending habit consistency. The larger pad you have, the safer you look to the lender. So, save.
Any large purchase, particularly on credit, will likely alter your DTI and credit utilization numbers. It may even put you out of range if you make a major purchase, such as a vehicle, camper, or other pricy item.
The waiting period between pre-approval and final approval isn’t the time to make major purchase. Even if it’s financing appliances or furniture, just wait until you close on the mortgage. Most lenders will pull all your info one last time during the underwriting process for final loan approval just weeks or days before you close.
6. Get Pre-Approved First Thing And Don’t Start House-Hunting At The Max
Don’t house-hunt before you mortgage-hunt. It’s a mistake that generally results in great disappointment and a lot of wasted time.
Around two months or so before you’re prepared to make an offer on a home, shop for the best mortgage. Look at rates, terms, mortgage products, and customer service. Once you settle on a lender, start the pre-approval process.
Pre-approval is when a lender looks at an overview of your finances (often just based on what you tell them) and credit to issue you approval for a maximum loan amount. It offers you insight on what price range you’ll likely be approved for when you get to the actual mortgage application.
This doesn’t mean that you must buy a home at that pre-approval price. It simply means that this is what the mortgage agent feels is the maximum amount the lender could ultimately approve.
By the way, many realtors actually require a pre-approval letter before they’ll show you their listings. It saves both you, them, and the homeowner a lot of wasted time. With pre-approval, the realtor is assured by a lender that you do have potential buying power within a certain price range.
Once you have an accepted offer on a home, the lender’s underwriting department will sift through your financials with a fine-toothed comb to issue final approval. They’ll ensure everything on your application is accurate and congruent with their unique lending formula.
It’s best not to start house hunting at the max pre-approved amount. It’s another common mistake that may lead to disappointment and delays.
To avoid finding yourself just over on DTI once you get to the precession of underwriting, it’s best to take at least 5K off the top of the pre-approved max. The more you utilize of that pre-approval amount, the higher risk you run of underwriting issuing a lot of contingencies to the approval or denying it because you’re pushing what you can afford to the max.
If pre-approved for $200,000, then search for homes $195,00 in under, and don’t waste your time looking at even a $201,000 home unless you have the cash to make up the difference via a larger down payment.
7. Be Prepared For A Down Payment
Down payments are designed to invest the mortgage applicant in the loan. The theory is that you’ll be more inclined to honor the terms of the mortgage by having your own money tied into it. In other words, it helps mitigate the risk of foreclosure.
The bigger the down payment…the more likely you are to be approved for the mortgage. As mentioned above, it’s also a way to offset the price difference between what the lender is willing to lend and higher priced homes.
Certain loans, such as a USDA loan or Veteran loan, require small, if any, down payment. Most standard bank mortgages, however, require at least 5%-20% of the home’s price in down payment, which may take some time to save up unless you have a great deal of equity in your current property.
8. Avoid Job Changes
Lenders ideally want to see a stable work history with limited to no gaps. Internal job transfers are usually not counted against you. Most lenders won’t approve you if you’ve been at your current job less than six months.
9. Look At Alternative Mortgage Products
If denied a mortgage because of a lower credit score, inability to make a big down payment, or lack of credit history, then you shouldn’t automatically give up.
Government insured loans, such as a FHA loan, may be able to help. Such usually require 3.5% down and accept credit scores as low as 580, and USDA and VA loans often require 0% down and have lower credit thresholds, too. Do keep in mind that the appraisal contingencies on government-backed loans are a little more rigorous, meaning fixer-uppers are typically a no-go.
In closing, the mortgage process isn’t such a big, freighting task once you understand all the components that go into approval. If you’re lacking now, then take a couple of months to improve your standing or explore alternative mortgage products. The most important part is timing your application ahead of house hunting and behind solid work to your financial portfolio.
