How lenders determine how much mortgage you qualify for when applying for mortgage?
If you are thinking about buying a home, one of the first things you should do is go to a lender to get mortgage pre-approved. This will determine how much money you can borrow on a mortgage. This will also help you filter your home search by sale price, which will narrow your choices within your financing range.
Here are the main factors how lenders to determine how much mortgage you qualify for.
Credit or FICO Score
The first thing lender will review is your credit score or FICO score. Your credit score may be the single most important piece of financial information about you. Your credit scores is based on your payment history, overall level of debt, length of credit history, types of credit and applications for new credit.
This is where all the decisions you made in the past regarding will be reflected, such as:
– How much debt you have outstanding
– How much debt you have in the different types of credit accounts (credit cards, car loans, school loans, etc.)
– Do you have a recent bankruptcy, late payments, or collections? If so, is there an explanation?
– Do you excessive monthly payments?
– Are your credit cards maxed out?
If your credit score falls within an undesirable range or includes unfavorable marks, traditional lenders might not able approve you for a loan. You may still be able to obtain a loan, but you will likely pay a higher mortgage rate, which will ultimately result in a higher mortgage payment.
Income
This is because your monthly gross income is used to assess the overall loan amount and if you can afford the payments, taxes, and maintenance for the next 15 to 30 years.
Mortgage lenders will typically use two ratios as part of the loan approval process.
PITI: The first is a ratio of estimated monthly housing expenses (principal, interest, property taxes and insurance) divided by your monthly gross income. This ratio is sometimes known as PITI or the housing-expense-to-income ratio.
DTI: The more important calculation is called the debt-to-income (DTI) ratio. DTI is calculated by adding the monthly payments of revolving accounts such as credit cards, auto loans, student loans and housing (rent or mortgage), and dividing that by your gross (before tax) monthly income. These ratios are usually expressed as a percentage and will quickly convey to the lending company your ability to handle the new mortgage debt.
What is Debt to Income Ratio (DTI)?
Down payment
If you have money set aside for a down payment, it can help lower your monthly payment because you get to borrow less. If the down payment is equal to 20% or more of the purchase price, you can avoid paying additional costs like Private Mortgage Insurance (PMI).
If you do not have the 20% saved for the down payment, you may still have some options depending on the type of mortgage you choose. The money used for your down payment must come from approved sources. This includes: investment account (401K, IRA), grant from an approved down payment assistance program, gift from relative.
How Important Is Your Down Payment when a Home?
Employment history
Your job history is an important consideration for your ability to repay the mortgage. Borrowers who have been working at the same job for two or more years will receive more favorable consideration than someone who hops from job to job. If you are self-employed or work for commission your lender may ask to see bank statements to substantiate past income history.
Collateral or the Property
Lender will only lend you certain percentage of the value or purchase price whichever is lower. Depending on the lender and the loan program you qualify, lender will lend like 80% loan to value (LTV) or maybe 90% LTV or maybe up to 96.5% LTV. In order to determine the value, you will pay the lender to order an independent appraiser to determine a market value of the property.
Conclusion
If you have less-than-amazing credit, then you may want to consider waiting to purchase a home and making changes in your spending habits to improve your credit score. The cost of homeownership extends beyond the monthly payment and includes routine maintenance and repairs, homeowners association dues and additional utilities that you might not have paid when renting.
Another thing is do not ever max out what lender willing to lend you. Just because you are approved to spend $3,000 per month on a house, it does not mean you have to go that high. Buying a home is a huge financial decision. No one should enter into it blindly and regret it later.
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