7 Things to Think About Before Applying for a Mortgage
by RJ Baxter
12 January 2006
So you want to buy a home? Unsure whether you will qualify?
I am here to tell you that applying and qualifying for a home loan is not as difficult as climbing Mount Everest or running a marathon, but there are some basic things that all lenders look for in your application. You can be lacking in one or two of these areas, but you must be strong in most of them in order to obtain a home mortgage. Let's explore the 7 things that lenders look for when determining if you are worthy of a loan.
Job Stability: Lenders want to see a 2 year employment history on your application. The best situation is if you have been with the same employer for two consecutive years or more. Frequent job changes or gaps in employment of more than a month must be explained and can jeopardize your chances of obtaining the loan.
Own a business? Business owners must also document a 2 year history of the business by providing a letter from their CPA stating that they have been in business for at least 2 years, or provide a business license showing the start date of the business, at least 2 years prior to application.
Don't have the 2 year history? Don't worry, if you are strong in the other 6 categories listed below, you can still obtain a mortgage. There are "No Doc" loans designed especially for you. With a No Doc loan, the lender does not verify your employment history, and you don't have to disclose it. However, you will pay a higher interest rate for this mortgage.
Income: Going hand in hand with your job history is your income. Lenders will also go back two years in this category by collecting 2 years W-2's and current pay stubs from you. If you are a business owner, the lender will take a two year average of your income based on the bottom line of your tax returns (after all write-offs). Same with commission income, you must have a two year history, and the lender will take an average over those two years.
As long as your monthly debt payments (auto loans, student loans, credit cards, and mortgages) are at least 41% or less of your gross income, you will qualify. If your ratio is higher than 41%, you may still qualify, but you must be strong in other areas.
Down Payment: The good news is that a down payment is no longer required to buy a home. The market has been inundated with 0% down mortgages in recent years. However, the terms of the loan (read: interest rate) will not be as good if you borrow 100%. Even putting 5% down will help you obtain a better rate. If you put 10% down, the terms will be better yet, and if you put the traditional 20% down, you will get preferential treatment and the best interest rates.
Reserves: This is a mortgage term which simply means money in the bank after closing. 1 month of reserves is one mortgage payment, taxes and insurance included. Depending on the type of mortgage you are obtaining, you will need 2-6 months of reserves after closing to qualify.
Credit History: You had to know we would get to this one. Credit history is a big deal to lenders and a big factor as to whether you qualify and how good the terms will be. The lender will look at your "fico" score, which is a computer generated number that helps determine your credit-worthiness. The formula for calculating the fico score is complex, but takes into account many factors such as pay history, collections, judgments, bankruptcies, and even residence and job stability.
Fico scores can range from 350-850, but are rarely under 500 or above 800. Here is a general guide as to what each range of scores mean:
499 or lower: You cannot obtain a mortgage with a credit score this low. You must repair your credit before applying.
500-579: "Subprime" You will likely have to have some sort of down payment to obtain a mortgage. Your interest rate will be quite high, and credit repair is recommended.
580-619: Still in the subprime category, but with a score in this range, you can obtain 100% financing, and your terms will be better. You may also qualify for an FHA loan, a government program sponsored by HUD that helps people qualify for favorable mortgages with better terms than subprime lenders.
620-659: This is the credit score range between subprime and prime loans. Lenders call this category "A-." If you are in this range, you will get rates slightly worse than "A" credit borrowers, but much better than subprime borrowers. You can obtain 100% financing, and you will have options.
660-680: This is the low end of "A" credit mortgages. You can qualify for the same mortgage as someone with perfect credit, but the rate will be slightly worse.
680-719: Your credit is slightly above the national average, and you can obtain the best terms on a mortgage. Credit in this range makes qualifying much easier.
720+: Scores in this range are considered the pinnacle of credit, and you will receive preferential treatment. With many lenders, your rate will be better just because of your perfect credit.
Characteristics of the Property: Depending on the type of property you are buying, the guidelines may be stricter, or the interest rates higher. For example, if you are buying a condo or a manufactured home, you will probably have to pay a higher interest rate. If you are buying a 4-plex or a condo in a high rise, you may have to come up with a down payment. Any property that has more than 4 units is considered commercial, and you must obtain a commercial mortgage.
Purpose of the Loan: Depending on the purpose of your loan, you will get different treatment as far as the requirements to qualify. For example, if you are refinancing your home, the loan-to-value ratio (percentage borrowed vs. appraised value) will be less if you are taking "cash out." If you are obtaining a construction loan, generally a down payment is required and you must have at least decent credit. The type of mortgage you are looking for might also require higher credit scores or more reserves, such as an investment property loan.
Hopefully, this article will help you get your ducks in a row before you apply. If you are strong in most of these areas, you can probably obtain a mortgage. Apply with an experienced and knowledgeable mortgage consultant who can help you work toward qualifying even if you don't qualify now. The best people in the mortgage business are in the business of helping people and are willing to work with you over the course of months or even years to guide you toward home ownership.
About the Author
RJ Baxter has been a mortgage consultant for four years. RJ utilizes his teaching background by educating consumers and advocating ethical business practices in the mortgage industry. RJ has received several awards for excellence and loan volume and has consistently ranked in the top ten among over 400 loan consultants at PrimeLending. For more articles like this, or to read more about RJ or PrimeLending, please visit http://www.rjbaxter.com/signup.asp.
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