These days, there are countless articles about how to make yourself more attractive in the physical world for prospective partners; but have you considered how your financial profile appears to prospective lenders? What will increase your chances of finding ‘the one’ when it comes to your mortgage financing needs? This article will touch on the most important factors you need to know about when trying to qualify for a home loan – or any type of credit for that matter.
This ain’t your momma’s mortgage:
In order to understand today’s lending guidelines and requirements, it’s important to know at least a little bit about the recent history of mortgage lending as a whole. Prior to 2008, the qualifying factors in order to borrow hundreds of thousands of dollars to finance a home were anything but strict. Quite the opposite, something called ‘no-doc’ loans were common practice among many lenders. No-doc loans took simply the word of the hopeful borrower on everything from income to employment to credit scores, with no verification required. No paystubs, no tax forms, literally NO documentation.
As one could easily imagine, this led to all sorts of exaggeration, which in turn meant that huge sums of money were given to people who lacked the ability to repay the borrowed amount. As more and more loans went into default, foreclosures soon followed, and what is known today as the ‘subprime mortgage crisis’ ensued. Investors lost fortunes, many families were forced out of their homes, and nobody came out a winner. Because of all this turmoil, regulations have been put in place to help make sure that a catastrophe of that scale never happens again.
Applying for a mortgage now looks much different than it used to. Every vital piece of information when analyzing the borrower’s ability to pay back the loan must be proven- documented and verified (and usually re-verified) before the loan closes and is funded. So… what is it that they’re looking for anyway?
There are 5 major components that make up a borrower’s financial profile: debt-to-income, loan-to-value, FICO score and credit history, current and past employment, and tax/income verification.
Also known as DTI, when assessing a borrower’s debt obligations, lenders will take a look at the monthly revenue from all sources (including employment, disability, social security, and pensions) and compare it to monthly payments. There are certain debts that are included (anything with an outstanding balance that needs to be paid down like cars, personal and student loans, etc…) and others that do not factor in (things like cell phone bills, utilities, and insurance payments). The amount of money owed is then divided by the income earned to give a percentage. For example, if your monthly debts add up to $1730 and you make $4500 per month, your DTI would be at 38.4%.
There are two types of DTI that lenders look at. The ‘front-end-DTI’ considers only the monthly housing expense compared to income. The ‘back-end-DTI,’ considered most important, includes all monthly obligations. When looking at back-end-DTI, the ideal candidate would be at 36% or less. DTI cannot exceed 43% in most cases; with the maximum allowable amount between 45-50% (in certain loan programs with other eligibility requirements met).
Another key factor in qualifying for a mortgage includes your Loan-to-Value ratio (LTV). That is, the amount you wish to borrow considered against the amount the property is currently valued at. Let’s say your home’s current value is at $500,000 and you’re looking to take out a loan of $350,000. This would place your LTV at 70% (350,000/500,000 = 0.7). The maximum allowable amount in most cases for LTV is 80%. There are certain FHA and government programs that allow for more, but you’ll also end up paying extra each month until you can get down below that 80% threshold. For Veterans who utilize a VA loan, LTVs of up to 100% are allowable.
Another reason your lender cares about your LTV ratio is that it can increase your options for other loan programs. If you have enough ‘wiggle room’ in your LTV, things like taking out extra money to consolidate monthly debts – or even getting straight cash – become possible. This is what’s known as a cash-out mortgage; and it’s a smart move if you have the equity to do so. With today’s incredibly low interest rates, there’s a potential to save thousands.
FICO Score and Credit Report:
You should be aware and prepared that if you’re looking to take out a mortgage, or refinance your current one, your credit will be run, and it will count as a “hard pull” the first time (but don’t let that scare you, there’s a 45-day window where additional inquires won’t count as much; as it’s expected for you to shop around for the best rate). Many lenders, like Network Capital, opt for a tri-merged report. This type of report pulls information from all 3 major credit bureaus (Equifax, Experian, and TransUnion) and will often provide 3 different scores. In this case, lenders will throw out the highest and lowest scores and look at the middle number to determine your qualifying FICO score.
Loans that conform to Fannie Mae and Freddie Mac guidelines do not allow for a score below 620. Anything above that will qualify for a conventional loan (assuming there are no disqualifying factors- like a recent bankruptcy- on the report). There are some instances where creditors will make an exception down to 600 (usually only with major compensating factors), however, don’t expect to even get an FHA approval if you’re below 580. Ideal borrowers hold scores at 740 and above. The higher your score, the better the rate offered to you will be.
Although it can be a frustrating qualifying factor for some, lenders consider lack of career stability a big risk. You should expect your employment and (verified) income to play into your qualification. Underwriters like to see a minimum of two years’ steady employment history at the same location. At the very least, if you’ve hopped around a bit from job to job, they’ll want to see that you’ve been in the same industry for the past two years.
To avoid any possible delays in the process, you may want to hip your employer to the fact that your lender may be calling or emailing to verify employment. In addition to employment verification, be prepared to provide your 2 most recent paystubs and copies of your past two W-2s. For those borrowers that are self-employed or have income properties; you should also assume they’ll want to look at your full tax returns for the past two years, including complete K1s and Schedule E if applicable.
If you’re going in for a purchase loan, make sure you have recent statements of all your accounts including: bank statements, retirement/IRA accounts, and any other assets that make up your portfolio. You should also know that they’ll want to see where your down payment is coming from. Whether it’s been gifted to you, is a loan you’re paying back, or comes from your savings directly, be ready to explain where the money came from; and all the details of repayment terms.
The Bottom Line:
When searching for the right mortgage product to fit your needs, it’s important to remember that there is no ‘one size fits all’ when it comes to loan programs. Everything from the amount you can borrow to the interest rate you obtain all depend on variable personal factors. One of the best practices is to simply speak to a licensed mortgage banker in your state to find out what the options are that you qualify for. Even if you don’t qualify right now, a good mortgage banker will be able to tell you what steps to take to get there as soon as possible.
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Disclaimer: The Mortgage Radio Show is sponsored by Network Capital Funding Corporation, a direct lender, NMLS11712.