With the $8, 000 first-time homeowner’s tax credit deadline approaching, many people are still trying to get in on the deal. If you’re in this boat, don’t assume that just having a down payment is enough (even though it’s a big help).
Applying for a mortgage involves a thorough check into your finances to see if you really qualify for a mortgage loan. This process takes time, and waiting to the last minute could cost you the tax credit.
Before you apply for a loan, you should be familiar with some numbers that the lender will be examining closely. The better you look to them, the better your chances of getting a solid deal on your mortgage.
Credit score
One of the first things that a lender will look at is your credit score. Not only does your credit score influence whether or not you’ll get approved, but it can also influence your mortgage rate. Be sure to check your credit report well in advance of any loan application, and fix any errors that you see.
Buyer’s income
Lender have to verify your income, so be prepared to provide W-2s, pay stubs, tax returns, and bank statements. If you’ve recently landed a new job, you might also be asked for a letter from your employer verifying your new salary. In our case, we were asked for two years of tax returns and recent financial statements.
Lenders are also looking to see if the savings you have is a gift or if you have saved up for it. Receiving a gift from a relative isn’t necessarily a bad thing, but you’ll need a mortgage gift letter to prove that it’s not a loan that has to be repaid. Prospective lenders just want to know the full extent of your obligations.
Debt-to-income ratio
Your debt-to-income ratio is a number that lenders use to evaluate the amount of debt that you’re carrying. It’s calculated by taking your debt monthly debt obligations and dividing that total by your monthly income.
Lenders are looking for lower numbers, as you’ll be more likely to be in a position to pay your mortgage. Lenders used to want your total debt obligation (including your housing expenses) to be no more than 28% of your income, though this number drifted up as high as 36% or even 40% during the housing boom.
Improving your debt-to-income ratio
There are two basic ways to improve your debt-to-income ratio:
Decrease your debt: Before you apply for a mortgage, reduce your long-term debt such as your car loan or student loan debts. You should also pay down your credit cards and negotiate lower interest rates, starting with any that are behind. If you are having a hard time now with debt, adding a mortgage will be a disaster. Reduce your monthly expenses and put that money towards reducing your debt.
Increase your income: Building additional income streams can help you immensely in the long run, and not just with getting a mortgage. If you have a review coming up at work, prepare diligently, and include concrete examples of your worth to the company. If they don’t want to give you a raise per se, see if you can negotiate a bonus if you reach a performance goal.
Loan-to-value ratio
This is another number for lenders to asses the risk of loaning you the mortgage loan. The loan-to-value (LTV) ratio is the mortgage loan amount divided by the appraised value of the property (expressed as a percentage). An independent appraiser usually determines the property’s value. If the buyer has a high loan to value ratio, they can expect to pay private mortgage insurance.
Private mortgage insurance (PMI) can add to your monthly payments so having a larger down payment or piggybacking your mortgage loan can lower your payments.
Cash Reserves
I read about this one in a few books covering mortgages, but I personally haven’t noticed this from our lender. Some lenders examine how much cash you have on hand to see if you’ll be able to weather any emergencies that arise. The cash reserves that we have are for the down payment as well as some for our emergency fund.
Closing thoughts
While it’s gotten harder to get a mortgage over the past year or so, that’s a good thing. It means that lenders are checking to make sure that borrowers can handle their mortgages. As much as I hate paperwork and filling out form after form (after form!), I also understand what’s at stake, and why the bank is being careful.
Have you noticed a change in mortgage standards?
I appreciate the feedback on your personal and professional mortgage experience. Sorry for the delay with my comments, I’m in training all this week. funny thing was that this topic came up during a break this week.
NCN, while we still have my student loan as debt, we had a similar experience. The lady was looking for credit card debt and car loans, but couldn’t find it. We explained we wanted to hold off on getting a house until we paid those debts off and save for a down payment. Apparently that made us a ‘slam dunk’ to get approved (her words not mine).
You are right…the process is a good thing and will ensure a more stable housing market. I would add one caveat to your post in that people shouldn’t try to get the housing credit before it is gone. For one, the government will probably renew or even expand the credit due to lobbying efforts by the NAR and homebuilders. Second, if the credit is not renewed, then home prices will probably drop by more than the $8,000 credit so you end up in a better position as you save the $8,000 as well as the interest costs on that amount.
Laura–From a recently ‘retired’ mortgage guy, this is an excellent post. You’ve captured the most important elements of the process.
I’d like to add that to anyone who hasn’t applied for a mortgage in the past three years, the process has gotten more restrictive and requires far more documentation than it has in the recent past. Never assume that you know how the process works because of your previous experience. Much has changed, so be prepared to cooperate and to be patient. Not much is being allowed to slide anymore, even if you have a top credit score or a large down payment.
My wife and I recently, just to see what we would qualify for, consulted a local bank about a possible mortgage. With just our W-2 and a credit report, we easily qualified for FAR MORE than we would ever want to borrow. Since we are debt free, our debt-to-income level was kinda funny – The guy had to put $1 in as “debt” just so that the computer would return a number.
We’re in the midst of getting a new mortgage (moved from OR to FL) and it is quite a different process than it was the last time we got one 3.5 years ago. I don’t think we even dealt with the underwriters last time, this time, we’ve received 3 requests so far to verify information or to clear something up. Amazing considering that we are getting the mortgage through the same company as before, our loan is for $35,000 LESS, we’re putting down 70%, have over 750 credit scores each, have no CC debt and make more money. Crazy!
This is a really great guide, in terms of explaining these factors in a way that makes sense. These are all important things to consider before applying for a mortgage, to improve your qualifications AND to determine whether you are really ready to take on the responsibility that comes with a mortgage. It’s also helpful to know what factors go into interest rates, here’s a guide written in a similar tone detailing these factors: http://tiny.cc/arD4z. Also, I wanted to add that there are efforts in congress to extend and even expand the Tax Credit that is set to expire on November 30.