It's important to understand the process of qualifying for a new mortgage loan. In essence, qualifying is merely a risk assessment performed by the lender to determine the likelihood that the buyer will repay the loan with the fewest number of delinquent payments possible. Action must be taken if you suspect that you may have any serious issues in your credit history over the past several years. There are some great credit repair companies out there that can quickly and effectively remove negative marks from one's credit report.
"FICO" scores are being used widely now to determine an applicant's creditworthiness. Depending on the amount of the down payment, lenders generally are looking for a "FICO" score of 620 to 680. The maximum score achievable is 850. The minimum is 450.
An underwriter will also determine an applicant's ability to repay the debt. This is done by plugging in the new proposed housing payment, including taxes and insurance, along with all of the existing debt that the applicant is carrying, and comparing that to the amount of income being generated in the household. The amount of proposed monthly payments is then expressed as a percentage of gross monthly income, (except for self-employed persons where net income is used). This is called a debt-to-income ratio. Most lenders do not like to see an applicant's proposed housing payments and required monthly payments on all other revolving and installment debt, (e.g. cars, credit cards...) exceed roughly 40% of gross income (or net income for self employed persons).
Some lenders will exceed that percentage if there are "compensating factors" in the loan file like high discretionary income, flawless credit, high reserve funds after closing, or an expectation of rapid income growth.
The underwriter will also review the home that is being purchased. They want to verify that the home is in good condition and that the purchase price is justifiable in the area. Banks do not like to make loans on overvalued property because their 90% loan can quickly become a 100% loan-to-value very quickly. And if they ever had to foreclose on such a property, it would lead to a substantial loss. Private mortgage insurance usually insures that the lender can recover the amount of the loan that was made, so there can still be some real risk even though the lender is insured through the PMI. Marketability and functional utility are also important factors that are analyzed by the underwriter. Some unique properties like cabins, geodesic domes, and high acreage properties can be difficult to finance because the pool of potential buyers for these unique home types are so much lower in number. And many banks don't want to get stuck owning one through foreclosure.
The last major aspect of the loan decision lies in evaluating the buyer's equity, or down payment. The lender wants to make sure that the funds being used by the buyer have been achieved through savings; equity in other sold assets, or gifted funds from a direct blood relative. Any type of borrowed funds is generally looked upon negatively. Lenders are very interested in the quality of the buyer's equity, especially when the down payment is relatively low (5-10%).
When keeping these major areas of concern in mind, a homebuyer can get a good feel for how the lenders go about approving home loans. And with this understanding the buyer can plan more effectively for their home purchase.
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