How Mortgages Are Approved
Here are some of the factors involved in the approval process of your mortgage application.
Income - Lenders usually use your gross income (all the money you earn before taxes) to determine the monthly mortgage payment you can afford. Gross income may also include the average of overtime pay and commissions, and child support or alimony.
Monthly mortgage payment as a percentage of your income - Generally, lenders require that your total monthly mortgage payment - (principal, interest, property taxes, mortgage insurance, hazard insurance and any homeowner association dues) - be no more than 28% to 33% of your monthly gross income.
Your total debt situation - Credit cards, car loans, student loans, child support, alimony or other monthly expenses. Lenders usually require that the total of all your monthly expenses (excluding basics like utilities and groceries) not exceed 38% of your gross monthly income.
Employment history - Lenders prefer to lend money to people who have worked consistently and whose incomes have grown steadily over the past several years. You may need to provide additional information about your work history if you're self-employed, work on commission or have been at your job less than two years.
Credit history - Paying your bills on time is an important part of getting a home loan. If you've had credit difficulties within the past two years, a good explanation of any late or missing payments on your credit report will be taken into consideration.
Property appraisal - A professional appraisal is done to determine the value of the home. An appraisal is based on the home's condition and selling prices of comparable properties in the area and confirms that the property is worth the purchase price you're offering for the home.
Review Your Credit Record
Having a good credit record means that you pay your rent and other bills on time. However, having less than perfect credit doesn't mean you can't get a mortgage loan. Understanding credit before you meet with your lender/broker can make the total loan process easier. Your lender will request a credit report as part of the mortgage loan process, so it's advisable to review your report before you meet with your lender. If there are discrepancies or errors in your credit report, you should contact the credit bureau to correct them.
- Credit bureaus gather information from credit card companies, banks, department stores, and other firms to compile a credit record of your debts and how you have repaid them.
- Your credit history shows how well you have paid your debts in the past.
- Capacity is your financial means for repaying your debt.
- Capital indicates whether you have enough money for a down payment and closing costs.
- Collateral serves to protect the lender if you fail to repay the loan.
10 Steps to get a Mortgage
Prepare yourself and consider all the factors when making that big investment - purchasing a home. It's important to research, ask questions, and study the process carefully - after all you could spend 25 to 40 percent of your gross income paying for your home. We've compiled resources to help you stay on the right track to getting a mortgage loan and buying your home.
1. Homework
Study and compare your choices in types of loans, where you get your loan from (banker vs. broker), consult an expert on any legal or financial matters you don't understand. Look into mortgage brokers, seller financing, a family loan or insurance company financing, there are more options than a bank. The cost of the mortgage shouldn't be your only qualifier, select the company that you have confidence is reputable and will deliver the loan with the terms and costs they promised. Ask family, friends and business professionals for referrals.Don't choose a lender just because they have the lowest rate, remember to consider the total cost of your loan including the APR, loan fees, discount and origination points.
2. Check your credit
Pull your credit reports before you apply for a mortgage, a preemptive examination of your credit report gives you time to correct errors, avoid any surprises, and otherwise clean up your credit act.
3. Get pre-approved, not just pre-qualified
You will have a better chance of getting a seller to accept your offer by being as prepared as possible. Put yourself in the sellers' shoes, you (as the seller) receive multiple offers to purchase your property, the buyer (you...a complete stranger) is asking to take your property off the market for at least two to three weeks while they apply for a loan. When meeting with lenders, always ask how they define each term and what additional steps will be required to obtain a loan.
- "Pre-qualified" - the mortgage professional is making a quick credit check about how much you can borrow based on information you've provided.
- "Pre-approved" - the mortgage professional has verified income, expenses, assets, liabilities and credit, as a result, much of the paperwork for the loan has been completed.
4. Choose the right loan for you
A loan is a product and one size doesn't fit all. Choose the loan that is right for you; if you plan on moving within a few years maybe an adjustable rate mortgage (ARM) with a low introductory rate or a zero-point loan. If you plan on staying in a home longer (or for life), perhaps look for a fixed rate and consider higher up front costs to obtain a lower rate. Be sure to look at initial interest rates, future interest rates and payments (if different), and the possibility of prepayment penalties. Investigate all your options, do the math and compare your choices side-by-side:
What can you afford? - Your credit report is the best indication of your credit worthiness. Excessive credit is almost as bad as poor credit or even no credit. Even if you pay your bills on time, lenders tend to focus just as much on how much credit you have available as they do on timeliness. So being up to your ears in car loans and credit cards is a sure way to be turned down for a mortgage. Postpone any big ticket purchases until after you buy your house.
Loan Length - The term (length) of a mortgage is 30 years by industry standards, but 15- and 20-year-term loans are also available. With a shorter-term loan, you can reduce your interest rate, (a 15-year rate is typically one-quarter to one-half percent lower than one for 30 years). You may need a conventional 30-year mortgage if you don't have sufficient long term income to handle the higher monthly payments of a 15 or 20 year loan. You can always make extra payments and save a bundle. Consider your monthly budget because the shorter the loan term (length), the higher the monthly payments.
Fixed Rate or ARM? - Fixed-rate mortgages protect you from the risk of rising interest rates, but you'll end up with a higher rate should interest rates fall. ARMs are a good choice for someone who knows their income will rise or at least keep pace with the loan rates periodic payment cap. If you plan to move in a few years and aren't concerned about the possibility of a higher rate, an ARM could be a good choice.
5. Shop for home insurance early
Start shopping for insurance as soon as you have an accepted offer. Don't wait until the last minute to get insurance, you'll get better coverage and better rates if you have time to shop around.
6. Get a home inspection
Independent home inspectors examine for roof and basement leaks, the mechanical systems and how long the appliances should last. It's highly recommended that you get property, roof and termite inspections unless you're buying a new home with warranties. Inspectors can't report on things they can't see, but their trained eyes are better than yours. Inspection reports are great negotiating tools when asking the seller to make needed repairs and this way you'll know what you are buying.
7. Get everything in writing
A written contract will override a verbal contract. Your state may require that contracts for the sale of real property be in writing.
8. Don't sign anything without reading it
Review in advance, any documents you'll be signing. Many of the documents you'll sign are standard forms and are usually available for review (even though specifics of your loan may be unknown early in the transaction). You won't have time to read all the documents at the closing.
9. Know your rights
Every consumer has the right to equal access under the law, to credit and the right to full disclosure of all costs associated with obtaining a mortgage. It's up to you to review and know your rights.
The Equal Credit Opportunity Act (ECOA) provides for equal access to credit regardless of:
- Race
- Religion
- Age
- Color
- National origin
- Sex
- Marital status
- Income from public assistance programs
There are additional protections if you have a physical or mental disability. The ECOA also requires that you are notified within 30 days of the completed loan application that your application has been approved as requested, modified, or rejected. Specific reasons for rejection must be given, in writing, to you at the time of rejection or upon your written request for the reasons.
Real Estate Settlement Procedures Act (RESPA) requires lenders to give you advance notice of estimated closing costs in purchase and refinance transactions.
Truth-in-Lending Act requires all lenders to fully disclose - within three business days after receiving your loan application - a written statement of fees, terms and conditions associated with a loan, including the Annual Percentage Rate (APR.), which reflects the cost of obtaining credit.
10. Allow for delays
Everyone wants real estate transactions to close on time, but usually transactions are delayed - sometimes a week or more. Let's say you ask your landlord to terminate your lease the day of your closing, then two days before your scheduled closing date the transaction is delayed. What happens now? Avoid this type of stress by terminating your lease one week after your scheduled closing, if there are any delays, your housing requirements are covered.
