In an environment where lenders are highly regulated and risk-averse, borrowers are rightfully a little nervous when they apply for a mortgage. But with the right preparation, qualifying for a home loan can be a rewarding experience in your journey toward homeownership.
"In a lot of ways, lenders have gone back to the basics, looking at fundamental personal finance criteria to decide who qualifies for a loan," says Rick Sharga, chief marketing officer of Ten-X, an online real estate marketplace in Irvine, California. At the same time, Sharga says lenders have been more risk-averse than ever since the housing bust.
A.W. Pickel, III, Midwest division president of AmCap Mortgage in Kansas City, Missouri, recommends finding a loan officer you can trust and sticking with that person during your entire homebuying process.
"A good loan officer is like a pilot flying you and your loan from Kansas City to Hawaii," Pickel says. "There are several ways to get there and several things that can happen on the way. A good loan officer has seen the turbulence and knows where the smooth air is."
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7 steps toward a loan approval
The back-to-basics approach by lenders means that borrowers can take steps that increase their chances of a mortgage approval. Improving your credit, reducing your debt and gathering your documentation are among the many things you can do long before a loan application to increase the likelihood of getting a "yes" from a lender.
1. Maintain a high credit score.
The average FICO score for an approved borrower is around 720 for a conventional loan and close to 700 for an FHA-insured loan, says Sharga. He says borrowers should find out their FICO score before applying for a loan, make sure their credit report is correct and take steps to improve their score if necessary. Pickel says he recently reviewed a loan file with a high debt-to-income ratio of 49 percent but a credit score over 800, which resulted in a loan approval. Keep a vigilant eye on your credit profile while you wait for your loan to close, too.
"Once the application process has begun, borrowers shouldn't do anything that might negatively impact their credit rating -- no new accounts, no late or missed payments".
2. Save for a bigger down payment.
One way to minimize risk for a lender is to make a higher-than-minimum down payment. "The average down payment today is around 10 percent; historically the standard has been 20 percent," says Sharga. "Anything above that lowers the loan-to-value ratio, which is viewed positively."
3. Choose the right loan.
If you have less money for a down payment but have good credit, you may qualify for a conventional loan with private mortgage insurance and a down payment requirement of 3 to 5 percent. You may want to look for a lender who issues FHA loans, which are often available to borrowers with less cash or a lower credit score and require a down payment of 3.5 percent. Keep in mind these loans require a monthly mortgage insurance payment in addition to principal and interest.
4. Manage your debt.
Lenders are reluctant to issue loans that fall outside qualified mortgage rules established by the Consumer Finance Protection Bureau (CFPB), says Sharga. These loans have a strict cap of a 43 percent debt-to-income ratio, which is the percentage of your gross monthly income that goes toward the minimum payment on all your debt, including your mortgage. Paying off credit card balances or at least reducing debt before applying for a home loan is helpful.
5. Buy within your means.
"Be realistic with your monthly income," Pickel says. "Buy a house with a monthly payment you can afford. Buying a house that needs the income from two or three future raises will only cause stress." It matters that you can afford your payments and have remaining income after those payments are made".
6. Demonstrate stability.
Lenders look for signs of personal and financial stability, such as whether you've saved three to six months' worth of expenses in the bank, whether you have a steady employment record and how often you've moved over the past few years, Sharga says. Your good credit score and a pattern of saving money are both indicators of financial strength.
7. Respond fast to lender requests.
The CFPB's ability-to-repay rule requires lenders to verify whether a borrower has the means to handle loan payments. This requires you to have all your financial records in order, including pay stubs, bank records, tax returns and more. Incomplete documentation is a common reason for loans being declined.
"If the loan officer asks for it, then bring it," says Pickel. "Sometimes people don't want to say they can't find something or they don't want to look for it, but it really helps to have all the information that the loan officer requests. This will help expedite the process."
While it should go without saying, honesty is an essential component of a loan approval.
"No one likes surprises, especially loan underwriters," says Pickel. "Tell the truth, even if it hurts. It will help even if it means that you don't qualify today."