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The Basics of Qualifying for a Home Loan
Looking to purchase a new home or refinance requires an understanding of the basics of qualifying for a mortgage. It helps to know some basic steps can help prepare for what is ahead. Learn how to be in a position ahead of time to get the best deal available.
Credit
A credit report is required from three major credit bureaus to document payment histories for auto loans, personal loans, credit cards, debt collections or other negatives. Credit scores are considered a predictor of lending risk. The higher a score, the better it looks to a potential mortgage lender. The following factors may also play a role in credit scores:
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Debt payment history, including late payments can influence credit score
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Credit card balances of more than 30-50 percent of credit limit can have a negative impact on a credit score
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Collections can damage your credit score but can be negotiated with the agency
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Bankruptcies and foreclosures have a general waiting period of around 2-4 years following insolvency prior to qualifying for new mortgage financing
Capacity
A mortgage lender wants to know an individual has the financial ability to repay a home loan. W2 income (working for somebody) is considered the most stable source of income which varies little from month to month. Self-employed income is riskier in a lender's eyes as it can vary widely month to month in terms of generating revenue to pay a loan. Some helpful hints include:
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Document income with W2s, paystubs and tax returns to demonstrate financial stability
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Self-employed individuals will be required to document income on tax returns and should be prepared to show the documents to potential lenders
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Debt-to-income ratio is important as it shows what proportion of income goes to debt payoff and risk for lending. Typical DTI should be lower than 45%-50% going to debt.
Collateral
The property being purchased will serve as collateral for the mortgage. A lender will look at the value of the property as one of the most important factors. A full appraisal may be required to verify the value and condition of the property.
Getting Started
The following are some great next steps to take when looking to take out a mortgage for a property:
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Check credit and make sure any issues are cleared up ahead of time.
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Pay off outstanding debt before applying for a loan. The lower the DTI ratio, the easier it is to get desirable financing terms. This can save money in the long run.
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When refinancing, take care of necessary repairs before having an appraiser come out. This will help the home value.
Having a financial portfolio that looks solid, has low debt and high credit scores can greatly increase the chances for getting a mortgage with better financing terms. Understanding how lenders think and preparing the portfolio will help individuals prior to applying for a loan search for a great deal and support a smoother process overall.