How to Get Approved for a Home Loan
No matter how long you’ve been “adulting,” buying a home is one of those milestones that so many Americans want to achieve. Nearly two-thirds of American adults own their homes, according to the U.S. Census — but how did all those people get there?
The prospect of buying a home can be tantamount to climbing Mt. Everest, especially if you are a first-time homebuyer. In this post, we’ll explore what you need to know — from what it takes to get approved for a home loan to what you should do if your loan application is rejected.
- What it takes to get approved for a mortgage today
- Obtaining a mortgage preapproval
- What you should do if you are denied?
What it takes to get approved for a mortgage today
Buying a home is one of the biggest investments you’ll make in a lifetime, so it’s important to treat the process with that level of importance. It’s easy to get swept away by a beautiful, pricey home and, if approved, take out a bigger loan than you have budgeted for.
Maintain a low debt-to-income ratio
Prior to meeting with lenders, you should do some legwork to ensure that you are truly ready to go down this path and what you can afford. With heightened regulations put in the place in the wake of the 2008 housing crisis, lending standards are tighter than they’ve ever been to ensure people aren’t borrowing more than they can afford.
To get approved for a mortgage, lenders will have to see that your total monthly debt obligations — that includes your mortgage payment — isn’t more than 36 to 45 percent of your monthly take home pay.
“To heighten chances of approval when applying for a mortgage loan, it is critical that applicants calculate a monthly home payment that takes into account how much home they can afford,” said John Schleck, a sales rep at Bank of America Home Loans. “Making sure you can meet your projected future home payment is probably the most important part of successful homeownership.”
Use this calculator from LendingTree to determine how much house you can afford.
Try not to change jobs or take on new debt
In advance of shopping for a mortgage, try to avoid any important finance-related life changes, said Robert E. Tait, a mortgage banker based in Doylestown, Penn. He refers to these as “income challenges.”
That includes changing your job, especially if you plan to work for yourself. A self-employed person is generally required to provide a minimum of two years’ of personal and business federal tax returns. If you’re switching from one regular W-2 job to another, then there shouldn’t be a problem; however, your lender will likely ask you for a letter explaining the job switch, however.
He also advised against co-signing a loan, buying a car, or taking on any new debt — even opening a new credit card — these can negatively impact your all-important debt to income ratio (DTI) and reduce your purchasing power.
Take time to clean up your credit
Over half of homebuyers today have credit scores of 700 or above, according to Ellie Mae. You can get a mortgage with a much lower score — as low as 500 with an FHA loan — but the better your score, the more affordable your mortgage loan will be.
Pull your own credit report and score so you know in advance what your lender will find when they are doing their due diligence. If there are credit-related issues, like late payments, collections notices, judgements or tax liens on your credit report, Tait suggests making those right as soon as possible.
According to Tait, “only time is going to improve your credit scores,” so give yourself a few months to repair your credit on your own before applying for a mortgage. Make sure you make on-time payments and pay down your credit debt balances as much as you can — these are the two quickest ways to improve your credit score.
The better your score is, the better your mortgage rate will probably be — even getting a mortgage rate that’s a few basis points lower can lead to huge savings on interest over the lifetime of your loan.
Look out for credit errors that you can dispute as well.
Choose your lender carefully
From financial institutions to mortgage brokers, there are so many roads you can take when choosing who to work with. Tait suggests polling your inner circle for recommendations. You’ll be working with the person you choose for a number of months, sometimes under stressful conditions, so you’ll want to work with someone who you feel will provide guidance all the way through the process.
“Borrowers need an advocate and someone who will under all circumstances act on their behalf,” he said. “It is important to be comfortable with your lender. They should be willing to spend as much time as needed to answer any and all of your questions, and to help and educate you as the buyer.” On LendingTree, you can fill out a short online form and potentially get matched with multiple lenders in your area.
Choose the right type of mortgage loan
Mortgages are not one-size-fits-all. In addition to a “conventional loan,” which suits the majority of buyers, there are other more specialized types of loans that you might qualify for. Different loans have different requirements, from the amount you are required to put down to how high your credit score needs to be to qualify.
FHA loans which are insured by the Federal Housing Administration and are geared towards low-income buyers with lower credit scores.
VA Loans are solely for veterans and other eligible borrowers.
Obtaining a mortgage preapproval
A preapproval is when a lender has deemed you to be a good candidate for a mortgage and is willing to put that in writing.
“We’re currently in one of the most competitive housing markets for home buyers, especially new home buyers,” said John Pataky, Chief Consumer and Commercial Banking Executive at TIAA Bank said. “Getting preapproved for a home loan gives you that extra half-step on the competition at a time when many houses are not on the market for weeks, but only for days or even just hours.”
To get preapproved, you typically need to submit your social security number, recent employment history, proof of year-to-date income, two years of tax returns, proof of residence, recent bank, savings and credit card statements and proof of any financial gifts you will be receiving.
Victoria Shtainer, a New York City-based real estate agent, that it can make sense to pursue preapprovals from more than one lender in the event that one lender approves you, but another does not. If you would prefer not to deal with multiple lenders, there are mortgage brokers who will pursue loan opportunities from a variety of financial institutions on your behalf. With at least one preapproval letter in hand, you can make an offer on a home knowing that you will be approved for the loan.
What you should do if you are denied?
Getting denied by a lender is very likely to cause panic, but Tait’s advice is to keep calm because all is not always as it seems.
If your loan application is denied, you will be provided with a reason. The most common reasons for denials are problems with credit history or debt-to-income ratio, according to a recent LendingTree study.
If you’re denied because of creditworthiness, all may not be lost. Seek out alternative borrowing methods like an FHA loan. There are a wide variety of loan programs designed to help people finance a home purchase for many different circumstances.
However, if it is decided that your financial records are not up to snuff, take a step back and revisit this process once you’ve had a chance to clean things up.
“Focus on improving what you can and spend a little more time saving for a bigger down payment,” said Pataky. “Work on ways to boost your credit score such as paying down high interest debt and building up a record of making payments on time.” He also suggested asking yourself whether the mortgage you applied for was the right size. Perhaps you should downsize a bit.
Shopping for a home is exciting, but remember how big a decision it is and avoid getting swept up in the process. Take your time, do your research, work with knowledgeable people and keep a clear head. If you encounter issues with your loan or don’t find the right home right away, fix things along the way and try again down the road.