Lenders will evaluate your credit history, employment history, current income, and debt standards to determine whether you are financially capable of purchasing a home. If you have a strong credit score and enough money saved for the down payment, mortgage approval is much easier.
The loan analyst will also verify your assets, including cash reserves and investment accounts, as well as real estate collateral that you already own.
1. Credit Score
Many people know that their credit score plays a big role in whether they’re approved for a loan or mortgage. But fewer understand how their credit score affects the actual terms of the loan, such as interest rates. Borrowers with higher credit scores are often offered lower interest rates, as lenders consider them less of a risk.
In general, a credit score tells lenders how likely you are to pay back the money you borrow, including your mortgage. The score is a number that is calculated based on information in your credit report, and it usually ranges from 300 to 850. The FICO and VantageScore credit scores are the most commonly used scoring models by lenders.
The credit score is based on your payment history, amounts you owe, and the length of your credit history. The longer your credit history is, the better your score will be. The credit score also takes into account your credit utilization rate, which is the percentage of your available credit you’re using. Lenders and creditors generally like to see this ratio below 30%.
When you apply for a mortgage, the lender will check your credit report to determine your credit score. They’ll then use that score to decide if you’re a good risk for lending you money and to establish the terms of the loan, such as the interest rate.
Even if your credit score is low, you may still be able to get a loan or mortgage if you have other factors that make you a good risk, such as stable income and substantial savings, strong employment history, and manageable debt levels. However, it’s important to work on building your credit health and reducing debt before you begin shopping for a home or other large purchases.
2. Debt-to-Income Ratio
Your debt-to-income ratio, or DTI, is a key metric lenders use to assess your ability to pay back the loan you’re applying for. Calculated by dividing your cumulative monthly debt payments by your gross monthly income, your DTI is an indication of how much you can afford to spend on housing, credit card bills, student loans, car payments and more. In general, lenders want to see a DTI of 43% or lower, though this varies by lender and type of mortgage, as noted in this breakdown from The Mortgage Reports.
While there are many factors that go into the DTI calculation, most include your housing expenses (mortgage principal and interest, homeowner’s insurance and property taxes), credit card payments, personal loans, car payments and alimony or child support. Lenders typically look at both front-end and back-end DTI ratios when evaluating borrowers for a mortgage, but the latter takes into account your proposed mortgage payment, as well as all other recurring, monthly debt payments, such as minimum credit card payments and utilities.
Keeping your DTI within the acceptable range is an important part of homebuying, as it can help you get approved for a loan with favorable terms and move closer to your homeownership dreams, particularly when dealing with Texas real estate investment property loans. If you’re struggling to bring your DTI within the range, consider reducing your housing budget or making a larger down payment to reduce the amount of mortgage you need to borrow and lower your overall debt burden. In addition to these strategies, it’s important to avoid adding any new debt during the homebuying process to help you reach your DTI goal sooner and enjoy the benefits of responsible financial management.
3. Down Payment
A down payment is an initial investment in a home that reduces the amount borrowed from the lender. It also helps buyers build equity faster by moving closer to outright ownership of the property. Down payments can affect how much buyers need to save for a mortgage and may influence loan approvals. Lenders tend to see a higher risk in borrowers who make smaller down payments and may require them to purchase private mortgage insurance (PMI), increasing their monthly home loan payments.
Typically, lenders recommend that buyers make a down payment of at least 20%. However, the size of a down payment can vary by location and home price. If a home’s price exceeds conforming loan limits, borrowers might need to make a larger down payment in order to qualify for the loan.
The down payment amount affects how much a buyer needs to pay at closing, including closing costs and other fees. During the homebuying process, a buyer’s down payment is usually deposited into an escrow account managed by a real estate attorney or settlement officer, and is then used to pay the seller at closing.
To prepare for a down payment, it’s important to start saving as early as possible. Some lenders even have down payment assistance programs to help buyers get into homes. It’s also a good idea to keep your down payment savings in an accessible place that provides a return, like a money market account or CD, so it can grow quickly. Lastly, avoid using your entire savings for the down payment; doing so can leave you “house poor,” meaning you’re spending too much of your income servicing your mortgage and depleting your emergency funds.
4. Loan-to-Value Ratio (LTV)
The loan-to-value ratio (LTV) is a financial metric that compares the amount of financing to the value of the property being financed. It’s a key consideration for commercial mortgage lenders, who use it to gauge the level of risk and borrower leverage in any transaction.
The LTV is calculated by dividing the loan amount by the property’s appraised value, and it’s typically expressed as a percentage. For example, if you’re purchasing a home that’s appraised at $100,000 and you make a 20% down payment, your loan-to-value ratio will be 80%.
It’s important for borrowers to keep their LTV low, as this helps them avoid becoming underwater on their mortgage in the future. Generally speaking, lenders prefer to finance properties with an LTV below 80%. This enables borrowers to have equity in their homes from the outset and gives them a vested interest in making their monthly mortgage payments on time.
In addition, a lower LTV reduces the need for mortgage insurance, which can add up over time and significantly increase your overall cost of ownership. The best way to lower your LTV is by putting down a large down payment when buying a home or refinancing.
Keep in mind, however, that a lender’s maximum LTV for a purchase or refinance may vary by lender and mortgage type, including jumbo loans and non-QM loans. Typically, government-backed and conventional loans follow agency or investor guidelines for loan-to-value, while private lenders may have their own requirements. It’s also worth noting that the LTV for a purchase or refinance can change over time, depending on market factors and other variables. For example, if the home appreciates in value, it will lower the LTV and help reduce PMI costs.
5. Lender’s Lending Guidelines
The lender’s lending guidelines play a critical role in determining your creditworthiness and approval for the loan. The lender wants to make sure it will be able to recoup the funds that are lent to you in the event of a default. Therefore, the lender will require you to put some money down on your home so it will have a greater stake in the property should you fail to pay.
The lenders will also look at your assets, which can serve as backup sources of repayment in the event you lose your job or encounter a financial hardship. This includes checking and savings accounts, investments, real estate and more. Lenders may have minimum asset requirements, which can vary by lender.
Most conventional loans require an unbiased opinion of your home’s value from a licensed property appraiser. However, borrowers who make at least 20% down on a one-unit residential property may be eligible for a property inspection waiver (PIW).
Lenders have a set of standards that must be adhered to when underwriting real estate loans, such as loan-to-value limits, and these are typically established by their board of directors. Examiners will review the institution’s lending policy during an examination and will note the number of exception loans that are granted in excess of supervisory limits.
The amount of exception loans a lender makes can be an indication that it is operating outside its own lending policies, which are designed to ensure safe and sound lending practices. It is important for an institution to review its real estate loan guidelines and determine if it should have certain limitations or restrictions in place to reduce the risk of an excessive volume of exception loans.
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