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What Do Mortgage Lenders Look For? Your Guide to Mortgage Approval



In today's competitive housing market, securing a mortgage can seem daunting. To increase your chances of getting approved for a mortgage, it is important to understand what mortgage lenders look for when evaluating loan applicants. This comprehensive guide will walk you through the key factors that can influence your mortgage approval.

1. Credit Score


The starting point for mortgage approval is your credit score. Most lenders will heavily weigh your credit score when deciding whether to approve your mortgage application.

Why is your credit score so important?
A high credit score demonstrates to lenders that you have a history of responsibly managing your debts and making on-time payments. This makes you a lower risk borrower, and as a result, potential lenders are more inclined to approve your mortgage application.

What is considered a good credit score?
Credit scores range from 300 to 850. Most mortgage lenders consider a score of 740 or higher to be excellent, while a score of 580 or above is usually the minimum required for approval.

To improve your credit score:
  • Pay your bills on time and in full.
  • Keep your credit card balances low.
  • Avoid applying for new credit frequently.
  • Regularly review your credit report for errors or identity theft.

2. Employment History


Mortgage lenders will review your employment history, including your current job, income, and how long you have been employed. They do this to ensure that you have a stable source of income, which increases the likelihood that you will be able to make your mortgage payments.

To satisfy most lenders, you should:
  • Be employed for at least two years in the same field.
  • Have steady and increasing income.
  • Provide ample documentation, such as W-2's, paystubs, and tax returns.

If you are self-employed or have an irregular income, you may need to provide additional documentation to prove your ability to repay the loan. This could include business financial statements, profit and loss statements, and additional years of tax returns.

3. Debt-to-Income Ratio (DTI)


Mortgage lenders consider your debt-to-income (DTI) ratio to make sure you can afford to take on an additional debt. The DTI ratio compares your monthly debt obligations to your gross monthly income.

Types of DTI Ratios
  • Front-end DTI Ratio: The percentage of your income that goes towards housing expenses, including the mortgage payment, property taxes, and homeowner's insurance.
  • Back-end DTI Ratio: The percentage of your income that goes towards all your monthly debt obligations, including mortgage, auto loans, student loans, and credit card payments.
To improve your chances of mortgage approval:
  • Aim for a front-end DTI ratio of no more than 28%.
  • Strive for a back-end DTI ratio of no more than 43%.
  • Consider paying down current debts to lower your DTI ratio.

4. Loan-to-Value Ratio (LTV)


The loan-to-value (LTV) ratio is the relationship between your loan amount and the appraised value of the property you want to purchase. This ratio helps lenders determine the level of risk associated with your mortgage.

How is LTV calculated?
Divide the amount of the mortgage loan by the appraised value of the property. For example, if you are seeking a $200,000 mortgage on a home valued at $250,000, your LTV ratio would be 80%.

Why does the LTV ratio matter?
The LTV ratio tells the lender how much equity you will have in the property. A lower LTV ratio is considered less risky for lenders, as it means you have more equity in the property, making it less likely that you would default on the loan.

To get a favorable LTV ratio, consider:
  • Saving for a larger down payment, aiming for at least 20%.
  • Choosing a less expensive home.
  • Exploring down payment assistance programs for first-time homebuyers.

5. Down Payment


As previously mentioned, the amount you put down on a home can greatly impact your mortgage approval chances. A larger down payment reduces the amount of money you need to borrow, your LTV ratio, and your monthly mortgage payment.

Consider these down payment options:
  • FHA Loans: Loans insured by the Federal Housing Administration require a minimum down payment of 3.5% for borrowers with credit scores of 580 or higher.
  • VA Loans: Loans guaranteed by the Department of Veterans Affairs are available to eligible service members and veterans with no down payment requirement.
  • Conventional Loans: Offer more flexible terms and do not require private mortgage insurance (PMI) with a down payment of 20% or more.

6. Property Type


The property you intend to buy may also impact your mortgage approval. Some lenders may consider certain property types riskier, as homes under foreclosure or short sales may require substantial repairs or come with legal liabilities.

Discuss with your lender any potential issues with the property type you're considering, such as multi-family homes, manufactured homes, or condos, and be prepared for additional requirements and documentation.

7. Appraisal


Lenders typically require a home appraisal to ensure that the property's value is in line with the amount you want to borrow. An appraisal protects both you and the lender from overpaying or loaning too much for the property.

If the appraisal comes back lower than the purchase price:
  • Negotiate with the seller to lower the price.
  • Challenge the appraisal and request a reevaluation.
  • Increase your down payment to lower the LTV ratio.

8. Liquid Assets


Lenders want to see that you have sufficient liquid assets to cover your mortgage payments, particularly in the event of an emergency. Be prepared to show documentation of your savings, investments, and other assets that could be converted into cash if necessary.

Having a larger amount of liquid assets may lead to:
  • Increased approval chances.
  • Potentially lower mortgage rates.
  • More favorable loan terms.

Conclusion


By understanding the factors that impact mortgage approval, you can take steps to improve your financial standing, increase your chances of securing a mortgage, and ultimately achieve your dream of homeownership. Monitor your credit, maintain stable employment, save for a down payment, and keep your debt-to-income ratio in check to enhance your overall profile as a borrower for mortgage lenders.


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