Purchasing a home is a huge milestone. Most people require a mortgage when buying a property. The mortgage approval process can be quite complicated, especially for first-time homebuyers who don’t know what to expect. Understanding what factors are important to your mortgage application can help you prepare and increase your chances of approval. In general, there are five main factors that lenders look at when considering mortgage applications,
1. Credit Score
Your credit history and credit score are a significant factor in any financing approval. Your credit score reflects how you interact with lenders – if you make payments in full, on time, if you spend beyond your means, and if you carry debt.
According to Equifax (one of the three major credit reporting agencies in the U.S.), a good credit score is between 670-739. Having a credit score below 670 doesn’t mean your mortgage application will be denied. Instead, it likely means that the bank will charge you a higher interest rate or ask you to find a co-signer.
Traditional lenders typically want to see a credit score of at least 620. A Federal Housing Administration (FHA) government-backed loan may approve a mortgage with a score as low as 500. And lastly, a Veterans Administration (VA) loan can be approved with no credit score check at all.
Not only does a high credit score increase your chances of approval, but it also saves you money in the long run by securing a lower interest rate from your lender. You can slowly improve your credit score by always making payments on time and in full, reducing your debt, and limit your number of hard credit inquiries.
2. Debt-to-income Ratio
The next thing a lender will look at is your debt-to-income ratio. This ratio compares your outstanding debt to the amount of income you make. If you already have existing debts, such as car payments and student loans, you may not have a lot of room for a mortgage loan. Lenders look at your income and want to make sure you have enough money to cover your debts, mortgage, and everyday living expenses.
Each lender will have its own requirements for a debt-to-income ratio, but generally speaking, lenders only consider giving mortgages to people whose debts make up 43% or less of their gross income. This 43% should also include your future mortgage payment.
So, let’s say you make $4,000 per month, and you have a $300 car payment, a $200 student loan, and an expected mortgage payment of $500. Your debt totals $1,000 and makes up 25% of your income. This will put you in the clear with most lenders and shows that you can afford all of your debt payments.
3. Down Payment
A down payment is another important factor in your mortgage application. Generally speaking, lenders want to see that you have at least 5% of your home’s purchase property saved up for a down payment. This shows that you’re committed to the purchase and capable of saving up.
The higher the down payment you have, the more likely you will get approved. Additionally, a higher down payment can mean a lower interest rate.
Applicants with a down payment of less than 20% will have to pay Private Mortgage Insurance (PMI).
VA loans and USDA loans can be approved with 0% down if you qualify.
4. Your Work History
When a lender approves you for a mortgage, they’re trusting you with a lot of money and expect to be paid back. As a result, they want to minimize their risk and only lend money to reliable people with a steady income stream. You will need to show that you’ve been working steadily for at least two years, with proof of income.
If possible, avoid switching employers right before you apply for a mortgage. Most new employers have a period of “probation” where they can let you go without cause. As a result, new employment adds an element of risk that lenders prefer to avoid.
5. The Property Value
Getting pre-approved for a mortgage is great, but there are a few additional crucial steps a lender takes before giving the final approval. One of these steps is the property appraisal. Your lender wants to make sure you’re not overpaying for the property. If you take out a mortgage for more than your home is worth and default on the loan, the lender won’t be able to sell your home and recoup all of their losses.
The home appraisal process protects both the lender and yourself – it is not in your best interest to pay more for a home than it’s deemed to be worth.
Always shop around when applying for mortgages. You want to make sure you find the best lender and the best rate. Potempa Team is proud to offer some of the lowest rates in Arizona for first-time homebuyers. Contact us today to get started.