It should be little surprise that lenders take a long look at the financial strengths and weaknesses of potential borrowers before approving them for mortgage loans. Mortgage lenders want to make sure that customers can truly make their monthly mortgage payment, without stretching their finances too thin. This is for the benefit of the borrower as well as the lender!
Here is what lenders will typically look at when determining whether you qualify for a mortgage loan.
Your three-digit credit score is an important number. Lenders consider this score when they are determining who to lend to and at what interest rate.
If your credit score is low — say, 640 or lower on the popular FICO credit-scoring system — you might not qualify for a mortgage loan from conventional lenders. If you do, you'll certainly have to pay higher interest rates.
That's because borrowers with low credit scores have a history of missing car loan, credit card or student loan payments. They might also have a bankruptcy or foreclosure in their past. Alternatively, maybe they are saddled with high credit card debt. All of these missteps will lower a credit score. Lenders are understandably wary about lending such a large amount of money to borrowers who have not managed credit well in the past.
If your credit score is excellent, which means a score of 740 or higher on the FICO scale, you'll dramatically increase your ability to qualify for the best mortgage and the lowest interest rate.
Lenders will also look at your debt-to-income ratio to determine if you are a good credit risk. Specifically, lenders want to determine the size of your gross monthly income — your income before taxes are taken out — compared to both your mortgage and other debts.
To do this, lenders will consider two ratios, your front-end, and your back-end ratios.
The front-end ratio takes a look at how much of your gross monthly income your monthly mortgage payment — including principal, taxes and insurance — will take up. In general, lenders want your mortgage payment to take up no more than 28 percent of your gross monthly income.
The back-end ratio considers all of your debts, everything from your mortgage payment to your student loan and car loan payments to the minimum amount of money you are required to send to credit card companies each month. Lenders prefer working with borrowers whose total monthly debts swallow no more than 36 percent of their gross monthly income.
The lender's goal is to make sure that your monthly debts are not so burdensome that they'll overwhelm you financially, once you add a monthly mortgage payment on top of them.
Lenders will look at your employment history, too, before lending you money for a mortgage. Most lenders prefer to work with borrowers who have spent at least the last two years in the same industry. They are even more interested in borrowers who have worked with the same company for those two years.
Lenders view such a work history as a sign of stability, and they prefer lending to borrowers whom they view as stable.
However, what if you are self-employed? You'll have to work a little harder to convince lenders that you have a stable stream of monthly income. You'll probably have to send your lender copies of your tax returns for the past several years to show them that your annual income, even though you've been self-employed, has been steady.
If you don't qualify
If you don't qualify for a loan today, don't panic. You can always work to improve your finances before trying again.
It is possible, for instance, to boost your credit score. You'll just have to create a new history of paying your bills on time. You'll also have to lower your credit card debt. Improving your credit score will take months, if not longer, but if you make good financial decisions, you can make it happen.
You can also better your debt-to-income ratios by paying down your debts and seeking ways to boost your gross monthly income. Maybe you'll find a better job or get a raise. At the same time, you can make yourself look more attractive to lenders by holding down your present job for a year or two before applying again for your mortgage loan.
In other words, don't give up. If you get rejected for a mortgage loan, work to improve your finances. You can still be a homeowner.
Want to get prequalified?
Get an idea of how much home you can afford, before you ever start house shopping. While prequalification isn't a commitment of credit, it provides an idea of how much you may be able to borrow. The process is quick and easy. Just talk to one of our mortgage lenders.
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