The housing market may fluctuate with the economic trends of the day, but one thing that often remains the same no matter what the current conditions bear is the difficulty many consumers will face when applying for a home mortgage.
For some it can be a long and frustrating process that ends in denial of their application for any number of reasons. But those who enter into the mortgage application process having done their homework first can greatly improve their chances for success, and it doesn’t require much more than taking some preliminary steps that will prove beneficial for matters far beyond application on a home mortgage loan.
Preparing to apply for a home mortgage loan is about taking a practical approach to home ownership by understanding the pitfalls, knowing how much home you can actually afford before submitting an application and getting your financial house in order so the loan companies won’t reject you. Lenders are looking for every reason to deny you a loan so you can use these 10 easy tips to make sure you don’t give them any option other than approval.
1. Know What You’re Up Against First
We all remember the economic crisis of 2008 and 2009, when everyone was getting approved for a mortgage loan no matter who they were, what their credit looked like, or if they could even afford the house they wanted to buy. The result was a disaster, as the “sub-prime” loans that were being handed out to anybody who asked quickly defaulted when these individuals had no chance of making the necessary payments.
These lending practices caused such a ripple effect throughout our economy that folks lost their homes or owed much more than the home was worth and the only ones who got bailed out by the government were the banks, to the tune of around $700 billion dollars. The massive impact is still being felt today in the form of increasingly rigid underwriting criteria that every applicant will have to successfully navigate if they want any chance of having their application approved.
Therefore, you will want to get all of your proverbial ducks in a row before you start this process. Although it may appear to be the case, applying for a home mortgage loan is vastly different than getting a car loan or even trying to rent an apartment. If you’re about to embark on the road towards a mortgage loan it’s very important to educate yourself on all of the requirements, standards, and expectations that lie ahead so you can meet these many challenges head on with confidence.
2. Budget Your Mortgage
Part of knowing what you’re up against in getting approved for a home mortgage loan is calculating how much home you can afford and how much you actually want to pay each month. They may sound like the same thing, but in reality they are different items entirely.
The first step towards figuring out how much home you can afford is by a standard rule of thumb that most banks and loan companies take into account based upon what your total housing payment adds up to each month. Most lenders try to keep an applicant’s monthly payment in a ballpark of 28% to 33% of that applicant’s gross income before taxes. Some lenders will let that number rise to 44% or higher, but that percentage is often reserved for individuals with exceptional credit scores.
If you want an easier time making your payment each month, keeping that percentage on the lower side makes the most sense. In determining what the payment would be each month, the lender factors in all fees, taxes, and insurance along with the price of the home, so that everything is fully covered in one monthly installment sum.
However, affording the payment is one thing, feeling comfortable making that payment every month is another. Keep in mind, you will also need to come up with a down payment on the home as well. Most lenders want the standard 10-20% up front, though if you qualify for an FHA loan or some other down payment assistance program then it might be less. The important thing is to set a number where you feel comfortable after factoring all of these variables into the equation and only seek out homes within your budget range.
Welcome to your first major hurdle. Your credit score can seriously derail this process by forcing you to pay higher rates and fees on your mortgage loan or getting your application denied entirely. So before you begin this lengthy process, make sure your credit report won’t hamper your success.
Obtain a copy of your report from the credit reporting bureaus (by law they are mandated to give you a free report every year) and check it for any errors or discrepancies that will prove detrimental to getting approved for a mortgage. The earlier you take this step the better, because if there are any mistakes on your report that demonstrate an inaccurate picture of your credit history, it can often take time to correct these problems. So if you are even considering buying a home and applying for a loan, get a look at your report first.
If everything on your report is indeed correct, then only you know what kind of road lies ahead for getting that all important “yes” from a lender. The FICO score most lenders are going to want to see is a minimum of 680 and even that number may result in some resistance to qualify you outright. The real sweet spot is a score of 700 or higher. If your number is far lower than these, you’re looking at higher interest rates and lender costs that will increase your payments each month and take more money out of your pocket over time.
Lenders are going to look at your report to see why your score is lower than they would prefer. It could be from any range of issues like a bankruptcy, consistently late payments, accounts sent to collections, credit cards with balances up against their limits, and an inordinate amount of monthly debt. Some lenders will listen to your explanation as to why these things are on your report, others will just simply say no. But don’t despair, you’re not entirely out of options. Many individuals who have less than terrific credit may qualify for government insured programs such as FHA loans, which will get you the money you need, though you will still be expected to pay more for the privilege.
Also, refrain from applying for any new credit in the weeks or months before you hand in an application for a new mortgage loan. Lenders get wary when they see additional new credit on a report, and they can tell if someone has done so much as a credit check on your profile. You may need to do some explaining no matter how harmless or inconsequential it might have been, but this can be reason enough for a lender to deny you a loan.
4. The Path to Approval
Your credit report may play a large role in whether or not you get approved for the loan you seek, but what exactly are lenders looking for when deciding whether or not to do business with you? In a word: ratios.
Any organization that is willing to offer a home mortgage loan takes a variety of factors into account and this list of determinants is combined to get a clearer picture of two different ratios that pertain to the size of your income and the total costs of the home and your overall debt. Every lender is going to want to know the following: your annual income, your monthly debt, the amount of cash you have available towards a down payment, the amount of house you can afford, and of course, your credit score. With these five elements, the lender can begin to paint an overall financial picture that provides them enough information on which they can base a lending decision.
You will be required to present a potential lender with all of the necessary documentation that proves your income and shows the monthly debt payments that you are already responsible for meeting. Pay stubs from the previous two weeks, at a minimum, will be requested from you, which is fine if you hold a steady job for a company or organization that employs you. Those individuals who are self-employed or work freelance and have an income stream that fluctuates from month to month will probably be expected to show pay stubs or tax returns over a two year period, again at a minimum, to demonstrate their annual income levels.
In addition, you will be expected to submit an accounting of any debts you currently hold and the monthly payments you are making to pay those down. Lending companies typically take items such as auto loans, student loans, and credit cards into consideration when determining your debt to income ratio. Obviously, you can help your situation by paying this debt off before you apply for a home mortgage loan, but if that’s unrealistic then at least refrain from taking on any new debt commitments of any kind, large or small, before you apply. Wiping out any ongoing debt will improve your credit score as well.
5. Getting Prequalified and Preapproved
Many potential homeowners who are planning to apply for a mortgage loan may be considering a pre-qualification or preapproval for their loan amount. However, they don’t always know the difference between the two and it’s important to understand what each one represents and if or when to obtain them.
The first of these, prequalification, can be done at any time with any lender and the purpose of this step is simply to get a preliminary determination from a lending organization such as a bank, lending company, or credit union that you should be able to get approved for a loan based on your credit score, your income, monthly debt, and additional factors that are considered. This prequalification is performed with the intention of finding out how much of a loan a borrower could be approved for and the down payment that would be necessary.
However, a pre-qual is not binding in any way and should be viewed as a hypothetical accounting of your worthiness towards getting approved for a loan. This initial judgment is mostly speculative as the lender hasn’t done all of the necessary due diligence required for a total approval, which is why a preapproval is often preferred by the lender and borrower alike as it provides a more accurate picture of whether or not a loan application would actually be accepted.
A preapproval is also more attractive to potential sellers because it shows that lenders are more willing to give you a loan because they’ve performed the necessary credit check and other financial evaluations. This step demonstrates you’re a viable candidate for loan approval by that lender (and likely others) and is usually more of a guarantee than a typical pre-qual.
Once the property has been appraised and a contract has been generated, the lender is prepared to give you the money. Potential sellers feel more at ease seeing you’ve been preapproved. Many lending organizations let you do this online and offer a quick answer after you give them the requisite information through their website.
6. Keep Your Employment Steady
It probably goes without saying, but implementing any major changes in your financial situation can prove detrimental during the home mortgage loan application process. If there’s one thing lenders love most, it’s stability. Keeping their minds at ease every step of the way is your responsibility, so refrain from changing jobs if possible as it can have significant effects on whether or not your loan gets approved.
Your financial picture has been carefully assessed under the current situations with respect to all of the factors that have been discussed so far. Therefore, it stands to reason that those situations may very well change significantly when your employment changes. If that’s the case, then you will likely need to start the entire operation from square one all over again. Quitting your job to start your own business or losing that job for any reason are definitely bad ideas while you’re applying for a home mortgage loan.
This is the very same for a situation that might go the other way and you get promoted to a better job with a bigger paycheck. While it may enforce your good standing with the lending company, it may still slow down the process as the numbers have to be reassessed with respect to income and debt ratio. It is crucial that once you submit information on your application to a prospective lender that information still applies throughout the duration of the process. Otherwise you’re likely to get denied.
7. Collateral and Qualifying for a Loan
Cash is an important component of any loan application and, when it comes to a down payment or collateral, it’s going to be important to have some amount of cash readily available. Lenders are unwilling to provide loans for more than a property is worth. This is why appraisals are such a vital part of the application process – if it’s determined that the property isn’t worth the asking price or any offer that’s been made, then the amount may be renegotiated with the seller and his or her representatives.
A borrower can elect to pay the difference between the amount of the loan and the sale price on the home if the purchase is made at the original asking price before renegotiation. If so, the borrower is going to need to have a considerable amount of available cash on hand as a form of collateral, because in the event the home isn’t really worth the amount it’s being sold for and the borrower has a loan that is more than the house is really worth, it’s very easy to get upside down on the loan and default. Therefore, having a cash collateral component in place will make qualifying for a loan much easier.
8. Saving Money
Cash is king and it helps anyone applying for a loan. As you prepare to position yourself towards the lead up of approaching lenders and auditing your credit report, start saving your dollars. Hold off on major expenditures and squirrel away as much as you can because the more you have in the bank, the more likely you are to be approved for a loan. The days of zero-down mortgage loans are long gone and if you have no accessible cash in your checking or savings accounts then you can pretty much expect to be turned down for a mortgage almost immediately.
Saving up for your loan (strange to even hear of such a thing, right?) is the best way to make sure it goes through successfully. You’ll be expected not only to have enough for the down payment, but other fees that can and will add up quickly. Appraisal costs, home inspection fees, application fees, title search costs, credit report fees, and especially closing costs are all going to need to be paid. The closing costs alone could run as much as 5% of the balance on your mortgage and those must be paid upfront before the lender will close the deal. So start saving now if you plan on applying for a loan.
9. Settling Down in a Home
We’ve discussed all of the essential elements you’ll need to have in place in order to get approved for a home mortgage loan, but we have yet to cover one very important aspect. Before all of the credit checks and budgeting and preapprovals are conducted, you need to ask yourself if you’re well and truly ready to buy a home. This is a major step in anyone’s life and home ownership brings with it a litany of responsibilities.
Is your life ready for this step? Have you ever lived in a home before? Does your job force you to travel often? Are you stable in your career or do you find yourself moving from one job to the next?
When you buy a home you’re making a lot of commitments and most people who take this step plan on living in the property for an extended period of time. It’s important to understand that a home is a long-term investment and, unless you’re ready for this type of commitment, then it may not be the right time to buy.
You may have other intentions such as buying it to flip the property or renting it out to make some additional income. These are both fine options, but know what you’re getting into before you decide you want to go through all of the hoops and obstacles that come with purchasing a home.
For those of you who have lived in apartment or condominium complexes your whole life, you may be used to things breaking or needing repair and a landlord or maintenance department coming in and taking care of the problem for you. When you own a house, the landlord or maintenance department is you and only you. Which means you will be the one responsible for fixing things or calling the proper professionals to come in and repair or replace items as necessary, and more importantly, paying for those things to be fixed and replaced.
Home ownership is much more than paying off mortgage payments, saving for a down payments and factoring in other costs. If you’re a handy person around the house able to make repairs and fix things that might break down, then you could be better prepared to own a home than most. Some problems will require a professional or, if you are a professional yourself, then even better as that’s more money saved.
Just keep in mind, there is more to home ownership than buying the home. You must maintain it as well, both inside and out, to make sure the property maintains its value. This can effect your loan down the line, too.
Our Final Thoughts
Buying a home isn’t easy. Getting approved for a home mortgage loan is one of the most complicated and laborious components to achieving that goal. In today’s economy, the path to ownership is tougher than ever and you’ll need to stack the odds in your favor when it comes time to apply.
Keep these guidelines in mind before you ascertain which lenders will be the most willing to help. To make it even easier for you, there are a number of online mortgage calculators available to let you do some exploratory assessments of the amount of home you can afford and the payments you’ll be required to make.
Anything that will make you more prepared and thus attractive to lenders is a good idea regardless of your credit situation because even consumers with good scores can still be declined. It’s all about the individual’s particular financial outlook, so be sure yours is as positive as it can be when you’re ready to seek out a home mortgage loan.