How Do You Qualify For A Mortgage Loan?

by Silicon Valley Blogger on 2012-03-0627

You finally found the perfect house and you’re close to realizing the dream of owning your own home…so close that you can taste it. It’s a great time in your life but are you really financially ready to achieve these goals?

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You’ll first need to ensure that you can afford the house you’re interested in buying. Here’s more on how to get some idea on how much house you can afford. As you go house hunting, you may also want to shop for a home loan; so to get the best home loan rates, you can conduct online loan requests. You may want to check out web resources to obtain multiple loan offers from several competing lenders. Bear in mind that before you can obtain a loan approval, there are a few requirements you’ll need to fulfill.

Criteria For Mortgage Loan Qualification

What does it take to get the loan you want? What do lenders want to know about you? Before mortgage lenders can grant you a loan, they of course would like to make sure you can repay them. Your finances will be pored over like never before, making this experience quite overwhelming especially for first-timers. There are many questions and a mountain of papers to fill out and sign before you even know if the house you have your eye on, can be yours. Mortgage lenders will need to consider your personal finances very carefully before making a decision. The qualification factors for securing a mortgage can be summarized into this easy to remember short list called the “4 C’s of mortgage loan qualification”:

  • Your Credit history
  • Your Capacity to pay back your mortgage
  • Closing Costs, Cash to Close or down payment
  • Collateral or the property you intend to buy

Let’s go through each in more detail. The mortgage lender will need to know:

  • Your credit history and credit score. This is why you want to protect and improve your credit status. You’ll have a better chance to snag a loan — especially when credit is harder to come by — if your credit score is good to excellent. A realtor friend told me that victims of the subprime lending debacle who may have had their credit adversely affected may need only wait a few more years to restore their credit or qualify for loans again. Lenders will look at your credit history over the past 5 to 6 years.
  • Your gross income each month. This will give your lender some indication of your capacity to repay your mortgage. You need at least 2 years of income to show, and as an easy screening exercise, this income should be at least twice or three times greater than what you anticipate your home loan payment to be per month. The rule of thumb is that an individual may qualify for a loan that’s three times their income while couples or partnerships (with joint loan applications) may qualify for a mortgage that’s 2.5 times their joint income. Of course, the requirements may change depending on the credit climate; for instance, during the credit bubble, lending requirements were looser so qualification levels were much higher (e.g. five times the borrower’s salary). Some other important points: you’ll have to show your lender proof of income stability by presenting them with salary or other financial account information going back around two or three years. This includes your W-2 information, tax returns and bank or investment account statements. Lenders will average out your income over those years to get a feel for your capability to repay your loan. They are looking for stability and predictability when it comes to these numbers. If you’re an entrepreneur, be aware that any efforts to try to bring down your taxable income may actually be a disadvantage if you foresee a mortgage in your future. Ultimately though, a lender is after your capacity to pay, so your income minus your debt payments and expenses will guide their decision.
  • Your down payment or deposit. What is the amount of money you plan to use as a down payment? The minimum can range from 0%, say if it’s a VA loan, to around 3% – 5% for a more conventional loan. In my case, I prefer to put down a higher down payment, say at least around 20%, to ensure approval (and a lower cost loan).
  • The kind of property you intend to purchase. Lenders have their eye on the risks that a mortgage applicant is taking, and one such risk is where the house in question is located. This means that your choice of home may influence your ability to get a loan. If the house you want to purchase looks to be in a higher risk area or doesn’t look marketable, then you may have a bit more difficulty qualifying for a mortgage or for the loan amount you are seeking.
mortgage loans

The lender will also be taking a look at your debt to income ratio, which is a formula designed to determine how prepared you are to take on additional debt. Different lenders will have different requirements for the debt-to-income ratio. For instance, conventional loans — typically a conventional loan from a bank or other mortgage lender — will require no more than 26% to 28% of month gross income for housing costs and not more than 33% to 36% of monthly housing plus debt costs. With an FHA loan, the housing costs should not exceed 29% of the monthly gross income and 41% of the monthly gross income. Here’s where we discuss the debt to income ratio in further detail.

Additional Factors Considered For A Mortgage Approval

Other factors mortgage lenders will consider in their calculations for a mortgage approval include the cost of your real estate taxes and homeowners insurance. Property taxes can be determined by talking to your real estate agent or by contacting the local tax office for more information. Homeowners insurance is a requirement for obtaining a mortgage; an estimate can be acquired from a local insurance agent. Make sure you have an accurate quote from the agency to get the right estimate.

Some areas will require additional coverage for floods, earthquakes and other hazards, depending on the location of the home. Also, if your down payment is less that 20%, you will be asked to obtain mortgage insurance or to take out a piggyback loan in order to reduce the initial loan to 80% of the purchase price.

Before you begin looking or getting all excited about a great house you have found on the market, take some time to get information about prequalifying for a home loan or getting a preapproval. To prequalify a borrower, the lender will evaluate their financial information and will estimate the loan amount they may be able to secure; there’s no guarantee that the borrower will actually get a mortgage. A preapproval involves taking the steps to apply for a mortgage that results in a loan commitment of a particular amount (subject to a home appraisal); getting one can help the borrower cut down the time needed to get a loan. This may save the home buyer a lot of time and trouble when house-hunting.

On the other hand, if you’re having trouble qualifying for a conventional loan, you may want to consider other loan types that are geared towards those with weaker credit.

The fact is, you’ll be better prepared to find the right mortgage and to offer a respectable down payment when you know exactly how much house you can afford. Putting in some research, preparation and time to understand your financial circumstances prior to buying a house will allow you to negotiate a better deal and possibly make the home buying process move along more smoothly.

 
Image Credit: The American Chronicle

Created April 10, 2008. Updated March 6, 2012. Copyright © 2012 The Digerati Life. All Rights Reserved.

{ 27 comments… read them below or add one }

Frugal Dad April 10, 2008 at 12:09 pm

Excellent rundown! I’ve heard that the 28/36 figures were relaxed in recent years and have really tightened back up in the wake of the subprime mess.

Scott Gostyla April 11, 2008 at 6:27 am

If the sand castle is my house on the Florida coast, what does the coming storm represent?

Silicon Valley Blogger April 11, 2008 at 8:02 am

The storm signifies the bottoming out of the real estate market in the coming year, if it’s not here already.

It was a subliminal message…. we all need to hunker down and be prepared.

Jesse April 11, 2008 at 9:37 am

Something to keep in mind frugal dad: its tightening up a bit, but for people with good credit things haven’t changed THAT much. Remember, 97% of all homeowners are paying their mortgages on time, its the 3% that are causing the mess…

Miranda April 11, 2008 at 3:15 pm

Great post. Very informative. It is worth noting that some with decent (but not necessarily great) credit are being shut out. But those with excellent credit will always be able to get a loan.

Save Money April 11, 2008 at 10:12 pm

Mortgages aren’t really that bad a thing though. You are given all that money and if something does happen in your life that drastically changes your Personal finance you still have that money as backup. If you were paying without a mortgage and there was a crisis then you wouldn’t have all that extra money to stop your fall.

Jim R. April 12, 2008 at 11:41 am

Nice detailed post. Credit scores, LTV, and assets now play a very large role in mortgage qualification. Those with lesser scores, but a DTI ratio below 43 should consider an FHA loan, as they are less score driven, yet provide very competitive rates.

Mortgage man April 19, 2008 at 3:51 pm

Interesting to see that in the US is not that different than here in the UK. The amount to put down as deposit increased on most products available, but there still are loans available for applicants with impaired credit.

UK Bad Credit Loans April 22, 2008 at 10:08 am

Merging all your debts into your mortgage loan can be both good and bad as a solution for debt consolidation. With the current rate of interest you can certainly benefit from this low rate compared to an equivalent stand alone loan which is secured on your property. However, what some people fail to recognise is the increase in mortgage payments could become a struggle. Assuming that people are already struggling, and hence the reason to consolidate in the first place.

As such the persons property can become even more at risk if they can’t make the payments due to the increased mortgage. Another option would be to take out an unsecured loan. Although the interest is higher, the flip side is you won’t lose your prooperty if you can’t make payments.

Think Money Blog July 29, 2008 at 3:25 am

Hi,

your readers might find this article useful also:

http://www.thinkmoney.com/expert-loan-views/1199/debt-consolidation-loan-vs-iva.asp

Thanks!

BlogLender November 13, 2008 at 7:42 pm

Nowadays you can’t go near a mortgage with an LTV approaching 80% and your FICO better be over 720.

Good piece by the way…..

DealMe December 6, 2008 at 2:50 pm

Nice write up, I am hoping the fed actually does that 4.5% mortgage rate rumor that is going around. I know I would be looking to buy then.

MarbellaPropertyGuy February 12, 2009 at 9:33 pm

Lots of info here I already know about, but there’s also a lot more that I wasn’t aware of.

CA March 19, 2009 at 2:27 am

Those who have good credit and who have a strong financial foundation will be granted loans though, despite how bad the loan industry is doing.

Michelle April 7, 2009 at 11:53 am

My husband and I were trying to refinance our home mortgage and we found sites to put us at ease during a very scary, and like you said, very overwhelming, first time experience.

Great post! Thanks!

Ann July 3, 2009 at 7:18 am

Mortgage loan modification has helped a lot of home owners in the verge of losing their homes. You certainly have everything to gain when you go for a loan modification.

Spanish Mortgage July 6, 2009 at 3:42 pm

We are finding that things have evened out somewhat. Nowhere near what it was 2 years ago but at least we are now getting mortgages to completion. Our best lender is doing 80% of purchase price BUT they are continually tightening the criteria for non-resident buyers and I mean by the week! It is an ongoing battle to get clients accepted as the debt-to-income ratios we use here keep changing according to the type of client (employed/self-employed, home owner/tenant etc).

Suzie August 3, 2009 at 11:24 am

Great post! It is worth looking at your credit history yourself before you apply in case you have overlooked any little glitches, that way you know you have the best chance when you apply.

Greg October 29, 2009 at 6:46 am

Discussing credit history is really quite informative, but I think modified mortgages are the right way to deal with loans.

ABedford November 11, 2009 at 9:45 am

Interesting to see that they use a percentage of income in the U.S. rather than a multiple of the income. A much better way of ensuring mortgage affordability than multiplying income.

I think anyone looking at a mortgage should seriously consider how interest rate changes would impact their ability to repay — after all that’s what started the credit crunch! People should allow for a minimum 2% change in their mortgage rate.

Mortgage Bro February 17, 2010 at 4:11 pm

Great post. I’m in the process of buying my first property at a relatively young age and have had some issues qualifying for a loan. I’m thinking about using some of the government incentive programs and first time buyer incentives to get started.

Paul February 27, 2010 at 10:06 pm

I get some great resources regarding FHA loans at fhamadesimple.com. There is so much that is out there on the net and it gets complicated. I have found this source to be easy to understand, hope it helps!

Tucson Mortgage Rates September 10, 2010 at 3:05 pm

There are still a lot of incentives especially for first time buyers if you just know where to look and whom to ask. Yes, it is harder right now to qualify, but lenders are willing to work with many people in order to get them qualified.

New York Bank Rates January 12, 2011 at 2:44 pm

Great article. However, if lenders really did follow these guidelines then we wouldn’t be in the mess we are today. If people just said, no co-signing, no BS creative mortgage financing, etc, there is no way even half of the mortgages that were written during the bubble years would have been approved.

Even now I’m still getting offers option ARM loans, HELOCs, etc. People never learn. Your article is how it should work, but it’s apparently quite different than what happened.

toni March 7, 2012 at 8:45 am

This is a great article that does need the recycling it’s been getting based upon the dates of the comments.

My situation is one that was briefly touched upon but I really need help. Due to the market down trends I chose to keep my house while purchasing a new one several years ago. A family member lives in the old house with me covering all costs; this is a non-negotiable item, unfortunately. I am consistently being turned down on refinancing because of a very high (over 50%) LTI. No lender will consider my investments as I am not withdrawing any of them. My FICO score has been over 800 for as long as I can remember; the last check (Feb. 2012) was a range of 803 to 833. I haven’t been late on a bill in I don’t know how long and pay all charge and credit cards in full each month. I’d like to refinance both outstanding mortgages (of course I’m upside down on one property and owe about market value on the other) What’s a girl like me to do? Any suggestions?

Silicon Valley Blogger March 7, 2012 at 10:55 am

@toni,

That’s a tough one to call toni. From my experience, different banks and lenders may have different restrictions and requirements in place. Even folks with very high credit scores may fall for a hitch like what you’ve explained. If I were in your position, I would try to do a few things:
(1) search out lenders and find out exactly what they require and see if those things can be addressed. You may be able to find a lender with more flexible rules.
(2) pay down whatever you can towards your existing mortgages to get them lower and perhaps more manageable (at least in the eyes of lenders).
(3) increase income in some way. Interestingly, I found out that lenders may take more kindly to a homeowner who shows history as an investment property owner with a track record. Unfortunately, you have someone in your other home who does not pay rent, I gather? It’s an unusual situation, but if this house was generating income, it may help the situation. Otherwise, finding out other ways to raise your income would be another option.

Hope this helps.

toni March 9, 2012 at 5:00 pm

Thanks -
1) I have tried, believe me I have tried. If I were to take $ out of investments I would be a shoo-in but I refuse to do that.
2) I am paying just over an additional 500 per mth as it is now, but again, I don’t want to take from ‘investments’ to pay off a mtg.
3) That’s also been investigated but if I were to do that I would a) exceed the free gift law, b) the person would have to accept the $ from me (going through an acct.) and then pay it back to me. Additionally, there are tax consequences to both parties and it would need to be in place for almost 2 years with corresponding bank records before any lender that I know of would consider it.. I’ve had various scenarios drawn up and with all of them it would end up costing more than the interest savings. I’m just trying to see the logic in all of this. I could just stop paying but I wasn’t brought up that way.

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