What Do Mortgage Lenders Look at When Approving Home Loans? 

Written By Marie Abendroth
Last updated August 4, 2021

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August 4, 2021

Simple. Thrifty. Living.

If you’re getting ready to buy your first home, it’s helpful to understand just what do mortgage lenders look at. Their main focus is minimizing the risk of default. They do this by verifying that you have the means to pay back the home loan. Beyond that, they must confirm you have a strong history of paying all your debts. To do that effectively, they look at all the following factors to determine if you qualify for approval.

Creditworthiness is the first thing on the list of what do mortgage lenders look at while processing home loan applications. To get a clear picture of your credit history, they take a peek at your FICO credit score. The lower your score, the higher the risk. This reflects your ability to buy items on credit and pay them off by the deadline.

Each type of home loan has a minimum score, with conventional loans landing in the 620 range. FHA and VA loans, on the other hand, allow lenders to consider buyers at 580 and above. Higher credit scores improve your chances of getting approval and help you get a great interest rate.

So, be sure to work on raising your score well above the minimum by:

· Paying down debt

· Making all payments on time

· Avoiding hard credit pulls

Beyond that, all you can do is keep your accounts open and in good standing without carrying high balances. This will help lower your credit utilization or the amount of credit you have available versus what you’ve used. Plus, it allows your credit history to age gracefully, showing years of spending restraint and on-time payments.

Income is next on the list of what do mortgage lenders look at while processing your application. While your credit score shows your willingness to pay off debt, income shows your current ability to do so.

For mortgage lenders, it’s important to show a consistent earnings history. To do that, you’ll need to show your salary, bonuses, side hustle earnings, and any other sources of income going two years back. You can do that with pay stubs, tax returns, and profit-and-loss statements.

You’ll also need to show all your assets, such as:

· Bank account balances

· Retirement accounts

· Stocks and bonds

· Real estate holdings

· Cars, boats, and other vehicles

Your mortgage lender will add up all your earnings and assets. From this, they can determine how much you can afford to borrow. Plus, they can use that figure to calculate an interest rate that reflects the risk of lending to you.

Your debt-to-income, or DTI, ratio shows how much of your income is already going toward paying down your current debt. With a look at this figure, lenders can easily tell if you’ll have anything left over to pay your monthly mortgage payment, homeowner’s insurance, and property taxes.

Calculating Your DTI Ratio

Mortgage lenders find your DTI ratio by dividing your current debt payments by your income. If your rent, car payment, credit card payments, and other expenses add up to $2,500 a month and you make $5,000 monthly, your ratio is 50%.

Most mortgage lenders want a DTI ratio of 43% or lower. Pay down as much debt as you can and minimize your other recurring expenses to hit that figure. Do this before applying for a home loan.

When it comes to what do mortgage lenders look at in deciding to approve a home loan application, a 20% down payment was the gold standard. These days, that’s not always true.

Although a high down payment will definitely improve your chances of getting approved, it’s possible to get by with less. You have to go through first-time homebuyer programs or get a government-backed mortgage, like an FHA loan, instead of a conventional loan.

You only need 3.5% of the home’s purchase price to get approved for your loan with those options. The lower down payment will impact your loan-to-value ratio, however.

The loan-to-value, or LTV, ratio represents the total loan amount compared to the value of the property you intend to buy. If you borrow $300,000 and the property costs $350,000, your LTV ratio is 85%.

Ideally, mortgage lenders want the LTV to sit below 80%, which is only possible with a 20% down payment. If you’re going through a government-backed mortgage program, then you might have an LTV of around 97% instead.

Mortgage Insurance

In most cases, until the LTV falls below 78%, you’ll likely need to pay private mortgage insurance or PMI. These payments are usually about 1% of the total loan value per year, adding up to $250 a month extra on a $300,000 loan.

As you pay off your home loan or the property increases in value, your LTV decreases over time. But if home prices swiftly fall faster than you can pay back your mortgage, you could end up with a ratio of over 100%. If that happens, then you could have to make PMI payments for far longer than expected.

Before you apply for a home loan, take an objective look at all these areas to determine if you’re likely to get approved for the mortgage type and amount you want. If not, then get to work on improving the weakest areas.

If your income doesn’t fit the bill, for example, then consider pursuing a promotion or otherwise switching to a higher-paid position. Alternatively, you can bump up your side gigs to pad your earnings without disrupting your day job.

Eliminating Debt

All the while, you can work on eliminating debt, helping reduce your DTI ratio, and freeing up more money for your homeownership expenses. Remember that in addition to the down payment, you’ll need to cover the cost of an inspection, appraisal, and all other closing costs to buy the home.

It doesn’t end there either. You must have enough income to cover your mortgage, homeowner’s insurance, property taxes, upkeep, and all your other monthly bills. If you’re buying a bigger home than you’re living in now, your utility bills will likely increase, too, demanding even more income to cover it all.

As long as you’re ready for what’s ahead, the journey toward homeownership is well worth all the effort. So, feel free to refer to this guide as needed to get ready to exceed your mortgage lender’s expectations in every way.

About the Author

Marie Abendroth

Marie is a skilled content strategist and SEO copywriter with a focus on helping people improve their personal finances and overcome their barriers to success. In her articles, she aims to provide up-to-date info that can help everyone better understand how to invest in a better future.  

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