22
Feb

Mortgage lenders look at your total financial picture, including your credit health and many other factors, when deciding if you should be granted a mortgage (as well as what terms and conditions will come with it, if you’re approved). Let’s have a look at what’s typically the most important to the underwriter who reviews your application.

No Recent Significant Derogatory Events

A lender will look to see if you have any significant derogatory events on your credit report, such as a bankruptcy, foreclosure or short sale. If you do, you’ll likely have to wait a period of time before you can apply for a new mortgage. The waiting periods are between two and seven years, depending on the circumstances.

Your Debt-to-Income Ratio

If you are eligible to apply for a mortgage, one of the most important factors in your application is your debt-to-income (DTI) ratio. Stephen Moye, Senior Loan Officer at Summit Funding in San Diego, California, said that a high DTI means an applicant is considered a higher risk. Essentially, the lender needs to know that you can afford to meet all your financial obligations before they’ll approve your mortgage application.

Your DTI is expressed in two ways:

Front-End Ratio: Your gross income from all sources before taxes divided by your proposed monthly housing expense (your new mortgage payment, including principal, interest, taxes and insurance, plus HOA fees, if applicable). The limit for this ratio is usually around 28%.

Back-End Ratio: Your gross monthly income from all sources before taxes divided by the sum of all your recurring debt payments. This number includes housing, student loan payments, auto loan payments, other loan payments, credit card minimum payments and any other monthly debt obligation like wage garnishment or lien repayment. This limit is usually around 43%.

So, for example, say you want to borrow $100,000 at 3.5%, your monthly housing expense might be $450 (principal and interest) + $200 (property taxes) + $50 (insurance) = $700.

If you pay $150 per month on a student loan, $175 per month on your car loan and your two credit cards have minimum monthly payments of $25 each, your total monthly debt obligation (including the $700 for housing) is $1,075.

You can meet both DTI limits if your income before taxes is $2,500 per month.

Remember: Each lender set its own DTI limits, so you may see them as a little higher or a little lower.

Limits on Recent Credit Applications

Potential lenders don’t want to see multiple recent applications for new credit on your credit reports. Applications imply that you want credit or have recently obtained credit, and that means your monthly financial obligations could grow without notice. Too many might indicate you have a desperate need for money, or that you handle credit obligations with a cavalier, not careful, attitude.

Lenders have a cutoff on what they want to see. So, for example, some may say they won’t approve anyone who has more than two applications for credit in the past six months or three in the past year. If you’re over the limit, your application may be automatically denied.

Inquiries can knock a few points off your credit scores, too. Because you want the best possible interest rate when you apply, you should avoid doing anything that might bump you down to a lower credit score range.

However, it is wise to shop around for different mortgages to make sure you’re getting the best deal. With that in mind, there are exceptions to how your scores are affected by these applications. You can shop around for the best loan without damaging your credit scores. Each mortgage lender inquiry that occurs within a certain number of days are grouped together and ultimately considered a single inquiry by the credit scoring agencies.

The number of days you have to shop depends on the scoring model you’re looking at. The newest FICO score, FICO 9, treats all mortgage inquiries within 45 days as one. Older FICO versions (and VantageScore) give you 14 days to shop. It may be wise to ask lenders you’re considering which model they look at so you are aware.

Not a Deal Breaker: Credit Scores

A low credit score won’t put you out of the running, but your scores will play a large part in determining the interest rate you pay on your loan. Generally speaking, the lower your credit scores, the higher the interest rate you’ll have (meaning, you’ll pay more in interest each month).

Most lenders offer several interest rates, depending on what credit score category you fall into. A lower score can be offset by strengths in other areas of the application (compensating factors), like a higher down payment. Again, a mortgage underwriter is most concerned with your total financial picture and will examine the factors that contribute to your score.

“Maybe the low credit score is due to a medical collection,” Moye said. He said that lenders will consider “What type of debt is it? How long ago? How late?”

Your Credit Personality Could Help or Hurt You

Mortgage applicants are also often evaluated on how they pay their bills. We know that utilization – how much debt you have compared to your credit limits – affects your credit scores. People with top credit scores tend to charge less than 10% of their limits. (That means if your credit card has a $5,000 limit, the reported balance is not more than $500.)

But credit utilization only paints part of the picture. What if you have a card with a $1,000 limit, you use it for everyday purchases, charge close to the full $1,000 every month, and then completely pay it off with every statement? If you wait to pay until the statement comes, your credit scores could suffer because the high balance was reported to the credit bureaus.

You can get your credit score to reflect the fact that you pay off the card every month by making your payment before the balance is reported, usually on or right after the statement closing date (typically well before the payment due date).

Can’t do that? You’ll be happy to know that some mortgage underwriters now also look at your payment habits. If you consistently pay off your charges, or you steadily pay your high balances down over time, you could be viewed as a more qualified applicant than someone who makes only the minimum payment and tends to make little headway against debt.

“Fannie Mae and Freddie Mac don’t want to penalize people who maybe charge a lot but always pay it to zero before going further,” Moye said.

Stable Employment, Even if Non-Traditional

Stable employment reassures the lender you can earn money on a consistent basis. This doesn’t mean that you can’t get a mortgage if you haven’t been consistently employed by the same company. In some industries, it’s normal to regularly move from one employer to another, so of course there are exceptions.

“It depends on the type of work you do,” Moye said. “It’s not uncommon for a nurse to be signed up with a registry and change jobs frequently. That makes sense. In Hollywood, key grips and props guys get a new employer with every job they work. Paystubs can come from different sources. It’s more about being able to derive consistent income.”

Assets Can Help

In addition to the down payment, the lender might want to see that you have cash reserves to cover six to 12 months of living expenses, and you might be able to meet that requirement with a retirement account.

You should know, however, that the less cash you have, the more expensive your loan will be. If you make a down payment of less than 20% of the purchase price, you will be required to pay private mortgage insurance (PMI). PMI protects the lender in case you default on the loan, and in some cases is required for the entire life of the loan.

Image: Rido