We really enjoy your information and recommendations on building our credit. We are ready to buy our first home this year. What are other items that lenders will consider when qualifying us for a mortgage?
Nancy, Grand Junction
You ask a great question! Let me share with you what most lenders look for when qualifying you for a new mortgage.
Depending on who you ask, there are four “C’s” of underwriting or key items a lender will review to quality you for a loan, but I like to add one more. They include character, capacity, capital, collateral and my extra, common sense.
Character is based on your credit, credit scores and credit history. This includes an analysis of how you have handled your past debt especially whether you have made past mortgage payments on time. While each lender may offer in-house loan products with different minimums, the most common minimum FICO scores to qualify for a loan include 620 for conventional, 580 for FHA and VA and 640 for USDA. Other factors are taken into consideration as well when determining whether you can qualify for a loan even with these minimums.
Capacity is based on your ability to repay the loan. Does your employment background reflect a history of your stability and your income? Since you are applying for a loan for 15 or 30 years, lenders want to make sure you have a good work history for at least the last two years in most cases. Lenders will also look at debt-to-income ratios.The front-end ratio looks at your total new mortgage payment, including principal, interest, taxes, insurance and your HOA dues. Most of the time, your payment should not exceed more than 33% of your total gross income. The back-end ratio includes your new mortgage payment and all your remaining debt. This should not exceed more than 41-45% of your total gross income. There are loan products that may allow you to have a higher back-end ratio and your lender can help you identity these if it is needed.
Capital is based on your cash reserves or money in the bank, savings accounts, etc. that will cover your down payment and closing costs. Certain loans allow you to have a gift or down payment assistance. If you are considering a refinance, lenders will want to review how much equity you have in your home. For example, we will divide your total loan balances by the appraised value of your house to determine your LTV or loan to value ($160,000 current mortgage balance divided an appraised value of $200,000 equals 80% LTV). Lenders also look at the amount of money you will have after your loan closes or cash reserves. If you are buying a rental property, additional months of cash reserves will be required.
Collateral is based on the market value or appraised value of the home. Certain loan products require specific qualifications for the home, based on marketability and the condition of the home. Loan requirements are different if you plan to live in the home (primary residence), use it as a second home or as a rental property. The review of collateral is basically divided into two areas: appraisal and loan-to-value.
Common sense considers other factors such as payment shock. If you are currently paying $300 per month for rent and your new house payment is $2,000 per month, lenders want to make sure you can afford the new house payment. How much in savings, cash reserves, etc. will be left over for all your debts after your house payment is also important. While you may qualify based on the debt ratios I mentioned above, it doesn’t always show a realistic side of how much you can afford and have left over for everyday expenses.
Once lenders collect all the required information, your loan information will be submitted through an automated underwriting system which provides an automated way to assess the overall mortgage risk. An approve/eligible response tells the lender that the loan meets the credit risk criteria and is eligible for purchase. This also allows the lender to provide you with your pre-approval letter.
Each loan product has different guidelines for maximum loan amounts, minimum FICO scores, debt ratios, down payments and up-front fees. I encourage you to ask your lender to provide all the financing options that may be available to you. The very best time to ask all your questions is at your initial loan application.
Finally, don’t focus on just the interest rate, but rather focus on the payment. Just focusing on the interest rate can be misleading since it is the APR (Annual Percentage Rate) and the total closing costs which can vary by lender. If you are comparing lenders pricing, just make sure you are comparing apples-to-apples and not apples-to-oranges.
Good luck on your upcoming home purchase!
Branch Manager, NMLS #1721861
Cherry Creek Mortgage, LLC, NMLS 3001