Getting A Mortgage: What Lenders Look For

Getting approved for a mortgage can be a complex process that requires a lot of documentation. The eligibility requirements vary depending on the type of loan and the lender. Generally, mortgage approval is based on a buyer's FICO credit score, debt-to-income ratio (DTI), income, employment history, and other factors. Pre-approval is often necessary before making an offer on a home, and it helps to determine a maximum loan approval amount. This article will explore the steps and requirements for getting approved for a mortgage, including the role of credit scores, income verification, and down payments.

Pre-approval vs pre-qualification

When applying for a mortgage, you may be asked to get pre-qualified or pre-approved. These are different types of early approval that can help you find and buy a house. However, it is important to understand the difference between the two.

Prequalification is an early step in the homebuying journey. It is a lender's estimate of what you could borrow based on a preliminary review of your finances. It can be completed quickly and conveniently online, in person, or over the phone in just a few minutes with basic information like your income and expected down payment. Prequalification is useful for first-time homebuyers who are establishing their homebuying budget and want an idea of how much they might be able to borrow. It is also helpful for narrowing down lenders.

Preapproval, on the other hand, is a more specific estimate of what you could borrow from a lender. It requires more documentation, such as W-2 wage statements, tax returns, current pay stubs, and bank and investment account statements. The lender will verify the information you provide and perform a credit check. If you are preapproved, you will receive a preapproval letter, which is an offer to lend you a specific amount, good for 90 days. Preapproval gives you bargaining power when making an offer on a house, as it shows sellers that you are a serious buyer who can secure a mortgage. It is especially valuable in a competitive market.

While both prequalification and preapproval are useful steps in the homebuying process, they are not guarantees that you will close the loan. After you find a house and make an offer, the home will still need to be appraised by a third party before you can receive final loan approval.

Credit score and credit history

Lenders will also want to see evidence of how you've handled debt in the past, including whether you've repaid your balances and made consistent, on-time payments. Your payment history and credit score indicate to lenders how likely you are to make payments in the future. A low credit score could be a reason for a mortgage application to be denied, so it's worth trying to improve your credit score before applying.

To get pre-approved for a mortgage, you will need to complete a mortgage application and provide documentation to verify your finances and creditworthiness. This includes W-2 wage statements, tax returns, current pay stubs, and bank and investment account statements. The lender will perform a credit check and review your documentation to estimate whether you have enough money to cover closing costs.

Pre-approval is as close as you can get to confirming your creditworthiness without having a purchase contract in place. It gives you a competitive edge over other buyers in the market and lets sellers know that you already qualify for home financing, increasing your chances of having your offer selected. Pre-approval also helps you determine a maximum loan approval amount and any obstacles you may face, such as excessive debt or a poor credit score.

Down payment

The down payment is the cash you pay upfront to complete the real estate transaction. It is your contribution toward the purchase and represents your initial ownership stake in the home. The mortgage lender provides the rest of the money to buy the property.

Lenders often look at the down payment amount as your investment in the home. Not only will it affect how much you’ll need to borrow, but it can also influence whether your lender will require you to pay for private mortgage insurance (PMI). Typically, you’ll need PMI if you put down less than 20% of the home’s purchase price. Your interest rate will also be influenced by your down payment. Because your down payment represents your investment in the home, your lender will often offer you a lower rate if you can make a higher down payment.

The amount of your down payment helps give your lender the loan-to-value ratio (LTV) of the property. Your loan-to-value ratio indicates how much you will owe on the home after your down payment and is expressed as a percentage that shows the ratio between your home’s unpaid principal and its appraised value. The higher your down payment, the lower your loan amount will be and the lower your loan-to-value ratio will be.

To get pre-approved for a mortgage, you will need to supply information such as W-2 wage statements and tax returns from the past two years, current pay stubs that show income and year-to-date income, and proof of additional income sources such as alimony or bonuses. A borrower's bank and investment account statements prove that they have funds for a required down payment, closing costs, and cash reserves.

Income and debt

Lenders will calculate your debt-to-income (DTI) ratio to decide how much you can spend on a mortgage and what your loan's interest rate will be. They will compare your monthly debt to your monthly taxable gross income to see that it meets acceptable debt-to-income ratios. For a conventional loan, most lenders want no more than 36% of your income to go toward debt payments and your potential mortgage.

Lenders will also want to see evidence of how you've handled debt in the past, including whether you've repaid your balances and made consistent, on-time payments. They will also want to see that you have a stable income and employment history.

To get pre-approved for a mortgage, you'll need to supply information such as W-2 wage statements and tax returns from the past two years, current pay stubs that show income and year-to-date income, and proof of additional income sources such as alimony or bonuses. You may also be asked about other debts, such as a car loan payment you made with a credit card.

Loan type

The type of loan you apply for will determine the requirements you need to meet for approval. For example, a conventional loan typically requires a higher credit score than a Federal Housing Administration (FHA) loan.

A conventional loan is any mortgage that is not insured or guaranteed by the government. Most lenders require a credit score of 620 or higher to approve a conventional loan. Lenders also prefer your debt-to-income ratio (DTI)—the portion of your income that goes towards debt payments and your potential mortgage—to be 36% or less. A lower DTI indicates that you are in a good financial position to take on more debt. Conventional loans also usually require a down payment of at least 20% of the purchase price. If you put down less than 20%, you will typically be required to pay private mortgage insurance (PMI), which increases your monthly mortgage payment.

FHA loans are government-backed mortgages with lower credit, income, and down payment requirements. You only need a credit score of 580 to qualify for an FHA loan, and you may be able to get one with a score as low as 500 if you can bring a down payment of at least 10%. FHA loans also have more flexible DTI requirements, with limits that vary from those of conventional loans. However, FHA loans require Mortgage Insurance Premiums (MIP), which are usually required for the entire payment term and can increase your costs.

Another type of government-backed loan is a VA loan, which is available to qualified active-duty service members, members of the National Guard, reservists, and veterans. These loans require a median credit score of 580 or higher and a Certificate of Eligibility (COE) issued by the U.S. Department of Veterans Affairs.

In addition to these common loan types, there are also non-conforming or non-QM loans that do not adhere to federal standards for mortgages, such as rules about loan size or required income documentation. These loans may have more stringent qualifying standards or require different evidence of income or credit management, such as proof of rental property income or rental payments.

Frequently asked questions