Have you reached the point in your life when you’re tired of renting and want to take the plunge into home ownership? Buying a home is an exciting step, but before you start packing, you may want to become familiar with the characteristics lenders are looking for in borrowers. That way, when the time comes to put in an offer on the home of your dreams, you’ll have the confidence that comes with having qualified for a mortgage. Here’s what you need to know before applying for that loan:
When purchasing a home, it’s best to have saved money for a down payment. Lenders want to know how much of a down payment you’re going to be making in relation to the overall cost of the home. This percentage is known as your loan-to-value (LTV) ratio. Lenders calculate your LTV ratio by dividing the amount you are asking to borrow by the value of the home you want to buy. Ideally, you want to have an LTV ratio of 80 percent or less. If you have a LTV higher than 80 percent you will most likely have to pay for private mortgage insurance. It’s therefore a good idea to save for a 20 percent down payment. If 20 percent is out of the question, it’s a good idea to put 15 or 10 percent down. That way you will have some equity in your home. Also, keep in mind that mortgage lenders will want verifiable proof that these funds exist, so have your bank statement.
Lenders generally require that your monthly home ownership costs plus other monthly debt payments – such as car loans, student loans and credit card bills – be no greater than 36 percent of your gross monthly income. Mortgage lenders look at your debt-to-income (DTI) ratio to determine how much this amount is and how much you can afford to borrow. This ratio is calculated by dividing your pre-tax income by the amount used to pay off debts on a monthly basis. Your credit card payments are included in this calculation as the minimum payment required, not the amount you owe each month. Your total potential mortgage payment should include taxes and property insurance.
Your credit score plays a major role in your borrowing and mortgage rate eligibility. A credit score of 720 or higher should earn you the most favorable interest rate. If your score is below 720 but above 675, you may no longer be approved for the best rate, but you should have still be able to find a good loan. If your score is below 620 you may fall into the “subprime” category which means it may be more difficult to find a loan with a low interest rate. Before you apply for a loan, it’s a good idea to take a look at your credit report to make sure there are no errors. All Americans are entitled to one free credit check a year. Also be sure to check your credit score three to six months before applying for a mortgage, so you have enough time to correct any problems. To get your actual credit score, you can visit one of the three major bureaus – Equifax, Experian and TransUnion – or get it through LendingTree.com. If your credit score is less than perfect, you can take steps to improve it before you buy a home. Read our tips on how to build a good credit score.
Your job history is also important in whether you qualify for a loan. Lenders will look more favorably at someone who has kept the same job for two or more years than someone who has changed positions frequently. However, some job moves are looked upon more favorably than others – particularly those resulting in equal or more pay. If you are self-employed or work on a commission, lenders will likely require more financial information from you, such as personal and business tax returns.
The bottom line
Buying a home can be a great investment. By making sure you have everything you need to qualify for a loan, you can begin your home shopping today with confidence that your mortgage application will be approved.