Qualifying for a Mortgage
But a lender does not really want to end up with your house. They want you to succeed and make those monthly payments that make the world (or at least the U.S.) go 'round. So when you apply for a loan, the lender will scrutinize your financial situation to make sure you are worth the risk.
You need to get your paperwork in order before you find a lender, but first you should understand the basic facts.
- Down payment. Traditionally, lenders have liked a down payment that is 20 percent of the value of the home. However, there are many types of mortgages that require less. Beware, though: If you are putting less down, your lender will scrutinize you even more. Why? Because the less equity you have in the home, the less you have to lose by just walking away from the loan. If you cannot put 20 percent down, your lender will require property mortgage insurance. (If you can only afford, for example, 5% down, but have good credit, you can still get a loan, and even avoid paying PMI. Ask your lender about an 80/15/5 loan -- an 80 percent first mortgage, followed by a 15 percent second mortgage and 5 percent down. This gives the lender more security, while saving you the cost of insurance.)
- LTV. Lenders look at the Loan to Value (LTV) when underwriting the loan. Divide your loan amount by the home's appraised value to come up with the LTV. For example, if your loan is $70,000, and the home you are buying is appraised at $100,000, your LTV is 70%. The 30 percent down payment makes that a fairly low LTV. But even if your LTV is 95 percent most people can still get a loan, most likely for a higher interest rate.
- Debt ratios. There are two debt-to-income ratios that you need to consider. First, look at your housing ratio (sometimes called the "front-end ratio"); this is your anticipated monthly house payment plus other costs of homeownership (e.g., condo fees, etc.). Divide that amount by your gross monthly income. That gives you one part of what you need. The other is the debt ratio (or "back-end ratio"). Take all your monthly installment or revolving debt (e.g., credit cards, student loans, alimony, child support) in addition to your housing expenses. Divide that by your gross income as well. Now you have your debt ratios: Generally, it should be no more than 28 percent of your gross monthly income for the front ratio, and 36 percent for the back, but the guidelines vary widely. A high income borrower might be able to have ratios closer to 40 percent and 50 percent.
- Credit report. A lender will run a credit report on you; this record of your credit history will result in a score. Your lender will probably look at three credit scoring models (one for home equity loans or lines of credit) and then average them to arrive at your score. The higher the score, the better the chance the borrower will pay off the loan. What's a good score? Well, FICO (acronym for the company that invented the model) is usually the standard; scores range from 350-850. FICO's median score is 723, and 680 and over is generally the minimum score for getting "A" credit loans. Lenders treat the scores in different ways, but in general the higher the score, the better interest rate you'll be offered.
- Automated Underwriting System. The days when Jimmy Stewart would sit down with you to go over your loan are over. Today you can find out if you qualify for a loan quickly via an automated underwriting system (AUS), a software program that looks at things like your credit score and debt ratios. Most lenders use an AUS to pre-approve a borrower. You still need to provide some information, but the system takes your word for most of it, without Jimmy having to vouch that the farm really is yours. Later on, you'll have to provide more proof that what you gave the AUS is correct.
Your lender will require some or all of the following when you apply for pre-approval for a loan:
-- Paycheck stubs for the last 30 days
-- Last two years of W2's or tax returns if you are self-employed.
-- Recent credit card statements
-- Two bank statements over last 90 days
-- Loan information on current home (if you own one)
-- 401K statements
-- Divorce decree (if applicable)
Next article: Understanding Mortgage Types
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