Mortgage qualification doesn't have to be difficult. There are multiple considerations involved in approving a mortgage loan, and most involve either a specific number or ratio. Here are a few things that can help ease home buyers through the process.
Mortgage Application: Check and Double Check
Fannie Mae's Uniform Residential Loan Application is used by most lenders and requires detailed information. Most of the time, this application is taken by mortgage loan officers or processors and input directly into underwriting software.Before meeting with a lender, then, customers should gather the following information and documents:
- Addresses for the last two years
- Employment for the last two years, including W-2s (or tax returns if self-employed)
- Most recent two pay stubs (if a W-2 employee)
- Statements for all retirement, investment and savings accounts
- Current value of all real estate owned, as well as its income and expenses
- If applying for a purchase mortgage, document the source of the down payment and closing costs
- Other sources of income, like child support, Social Security,disability (only if using income to qualify)
A key to a successful mortgage application is allowing enough time to gather needed information and review the application form for error sand missed information.
Credit Scores: Mortgage Qualification by the Numbers
Conventional mortgage lenders typically require credit scores above 740 to offer the best mortgage rates. According to FICO,the company that developed the credit score model most frequently used in the U.S.,credit scores are derived from information contained in consumer credit reports. Consumers can check their credit reports each year for free by ordering them on the government's Website, www.annualcreditreport.com. They can also check their credit score for free at LendingTree – there's no obligation and users are never asked for credit card numbers.
Checking credit before applying for a mortgage can help prospective home buyers correct any errors and know how qualified they are.
Knowing their credit scores can also help consumers choose the right mortgage program.
Those with lower credit scores may qualify for home mortgages with FHA, USDA or VA loans. The FHA allows mortgage approvals with credit scores as low as 500, but while the agency allows bad credit scores, it prohibits loans to people who don't manage their debts responsibly and whose recent credit history has derogatory information in it.
In addition, FHA lenders are allowed to add their own mortgage qualification requirements. For example, while FHA guidelines may allow a loan approval with a credit score of 580, a lender can "overlay" the FHA requirement with its own requirement of a minimum 620 credit score. Applicants concerned about qualifying may have to contact more lenders and ask about overlays.
VA loans are available to eligible U.S. veterans, servicemembers and others who meet VA eligibility requirements. Although VA loan guidelines do not require a minimum credit score, the VA expects its network of lenders to use "good judgment and flexibility" in approving VA loan applications.
Home Mortgages and More Math
Lenders calculate certain ratios as part of the mortgage qualification process. Here are the most common.
Front-end ratio: Divide the prospective housing expense (mortgage principal and interest, property taxes, homeowners insurance, HOA dues, etc.) by the monthly gross (before tax) income. For example, an applicant earning $4,000 a month with a $1,000 housing expense has a front end ratio of 25 percent.
Debt-to-Income ratio (DTI): Also called the back-end ratio, the DTI is calculated by dividing borrowers' monthly mortgage and minimum debt payments (auto loans,student loans, credit card, etc. – but not living expenses like utilities) by their gross income. So if the applicants above has a $250 car payment, a $200 student loan payment and a $50 credit card minimum, her total expenses including the prospective house payment are $1,500. That makes her DTI $1,500 / $4,000, or 37.5 percent. According to the Consumer Financial Protection Bureau (CFPB), mortgage lenders shouldn't allow a maximum DTI ratio exceeding 43 percent.
Loan-to-Value (LTV): The loan-to-value ratio is the total owed on a property divided by its value. An $80,000 mortgage against a $100,000 property has an LTV of 80 percent. In general, borrowers with lower LTVs pay lower mortgage rates. LTV ratios higher than 80 percent require borrowers to pay for private mortgage insurance, FHA mortgage insurance or a funding fee for a VA loan.