Buying a home for the first time? Read below to see what mortgage lenders need from you.
Getting a mortgage is not as easy as it used to be. Banks and lenders make it much harder after the subprime crisis.
What this means to new borrowers is that you need to be well qualified for a mortgage before you apply.
But this doesn’t mean new and young borrowers are out of luck. You can still get approved for a mortgage with some basics in place.
So what it does it take for mortgage lenders to approve you for a home loan today?
If you’re on the market or thinking of purchasing a home in the near future, here are few things you should know.
So without any further ado, here’s what you need to learn and do before applying for a mortgage.
1. Your Credit Score Should Be 700+
The importance of having and maintaining a good credit profile can’t be overemphasized. A mortgage is a huge responsibility. The mortgage lenders risk a lot of money extending mortgages. And rightfully so, they’ve become more cautious since 2008’s subprime mortgage crisis.
Back then, you could qualify for a loan with no money down without good credit. Borrowers with a credit score below 669 were called subprime borrowers. And the mortgage lent to them was considered a subprime loan. It meant high risk for lenders, but it was still fairly easy to get mortgage loans without good credit.
Many of those home buyers could not afford and ended up defaulting on their loan. Since then, subprime mortgage vanished with new regulation and lenders are more cautious.
Today, you are expected to have “good credit” to qualify for a loan, and the higher your score, the better rate you can get.
According to Carrington Mortgage Holdings, a score in the mid-700s is their current average.
In the credit score range of 300 to 850, a score above 720 is generally considered a “good credit”. A score below 600 is considered very high risk and met with extreme caution by lenders.
To qualify for a mortgage, good credit is essential. To get a favorable mortgage rate, excellent credit is a must.
2. Proof of Your Income
Income verification is a must when applying for a home loan. Providing proof of income is one way the bank or lender can see you that you can afford the mortgage loan.
But your proof of income is more than just handing over a few pay stubs.
Your lender will need to see your earning are stable before they can approve of you. You also need to show your source of the down payment.
To verify your income, your mortgage lender will likely need to see a couple of your most recent paystubs. To add, you also need to show your most recent W-2 forms.
In some cases, you may get requested to show proof of income letter from your employer. This is especially if you recently change jobs.
To smoothen the process, pre-approve yourself by getting the following documents ready:
- W-2 statements from the past two years
- Recent pay stubs that show proof of income
- Proof of additional income such as alimony
- Income proof letter from your employer (as needed)
- A copy of your credit report – more about this later.
Proof of Income For the Self-Employed
If you are self-employed your tax returns are the main form of income verification.
Your lender will want to see at least a two-year history in the business with stable or rising income.
Be prepared to show your financial statements as well as your recent years of tax returns.
Why a Mortgage Lender Need Proof of Income?
To lend you a large sum of money as a mortgage, your lender needs to verify your qualification.
They need to see that you can pay for your mortgage.
Simply put, they want to see that your income can cover your home loan payment and other debt payments you have.
As a rule of thumb, your mortgage payments shouldn’t exceed 28 percent of your gross income. To note, this includes your property taxes as well as homeowner’s insurance.
3. Know Your Debt-to-Income Ratio (DTI)
Your debt-to-income ratio (DTI) is something many mortgage lenders really pay attention to.
But only a few borrowers know their number.
So why does debt-to-income ratio matter?
Your DTI gets calculated by dividing your monthly debt payments by your gross income.
Your monthly debt obligations are the sum of your credit card bills and student loans.
The gross income is your pay before taxes and any deductions.
DTI is an important measure for your lender as it measures your ability to manage a mortgage.
It may affect their decision to approve or reject your loan application. Moreover, it affects how much and at what interest rate they decide to offer you.
In essence, it alerts the lender of your realistic budget for your mortgage payment.
The DTI criteria and requirement tend to differ by lenders and loan products. Be sure to look at your mortgage options and multiple lenders to choose the loan that’s right for you.
What is Your Debt-to-Income Ratio Means?
In other words, what score do you need to achieve to be favored by your lenders?
Many lenders like to see borrowers’ debt-to-income ratio between 28 and 36%.
Be on the alert if yours exceeds 36%.
Lower the percentage, fewer debt obligations you carry. This undoubtedly makes you more favorable to your mortgage lender.
If your score happens to be over 36%, it’s not the end of the world.
In some cases, lenders may allow debt-to-income ratios of 43 % for borrowers with good credit. A large down payment or sizable financial reserves may be accepted to offset the low DTI.
The Bottom Line
Gathering all the required documents above can save you a lot of headaches later. It’s better to be over prepared than not.
Better yet, print out all your statements and bring to your pre-approval appointment. It’ll not only save you time but also ensure your approval process to go as smoothly as possible.
Applying for a mortgage can be nerve-wracking first time around. I hope this article helps make the process a little easier for you.
Comment below and let me know if you have any questions.