Tips for Getting Approved for a Mortgage
When it comes to applying for a mortgage, there are many things you can do to improve the likelihood of getting approved. Applying can be difficult and time consuming, but with the right approach, the reward will be worth the time and energy spent. We’ve created this guide to help you understand how lenders qualify potential buyers and what you can do during each stage of the process to improve your chances of being approved for the mortgage you really want.
How Lenders Qualify Potential Buyers
Since the financial crisis of 2008, lenders have tightened restrictions and longer approval processes. Before approving a loan, financial institutions are now required by law to review a number of documents and verify basic criteria to ensure a buyer is well qualified. Because of such restrictions, it is important to be prepared before submitting your mortgage application. This is a step often overlooked by first-time homebuyers, who end up scrambling to find the documents needed to supplement their application. Lenders will require these six items, so organize your documentation early on to keep the process running smoothly.
1. Your Income
Your income is one of the most important factors when determining your eligibility for a home loan. Lenders need to see a history of stable monthly income, so it’s essential to provide proof of your income. A traditional W-2 is ideal, but you should also make available additional income statements from contract work, rental income, disability income, spousal support, veteran's compensation, pensions, contract employment, and any additional source to round out the full scope of what you earn. And remember, when applying with a partner, lenders will consider both incomes.
2. Your Debt
Along with your income, a lender will need to be aware of any outstanding debt. This can include student loans, vehicles, unsecured credit card debt, or notes on other properties you currently own. Lenders use this to calculate your debt-to-income (DTI) ratio, which helps them determine if you are financially fit to take on the mortgage.
A high DTI indicates that you are overextended financially. Because you are using so much of your monthly income to pay off other debt, you may not be able to make the payments required for the mortgage you’re requesting. Typically, a lender wants to see a DTI around 36% or less, but each may spell out specific requirements for a loan. If this is a concern, you should focus on getting out of debt before beginning the mortgage application process.
3. Your Assets
Once a lender determines your DTI, they will want to know about any assets you have. You will provide verification with copies of monthly and annual bank statements for all accounts, deeds on other properties, or other similar documentation to show what you have and what it is worth. A few of the most common examples include:
- Retirement Accounts
4. Your Credit Score
While lenders may pull your credit report from any of several major credit bureaus, they will most likely summarize the report into a single credit score - typically a FICO score. Things like your payment history, length you’ve had your accounts, and your credit utilization will determine your score. It’s important to remember that your credit score can have a significant bearing on what sort of rate and term.
5. Your Employment History
Prospective lenders consider employment history important, because it demonstrates your likelihood to make consistent payments. They will likely verify your current employment status, as well as request your employment history dating back several years. You should be prepared to provide contact information for your previous employers.
6. Home Value vs. Loan Amount
In addition to assessing your personal financial health, lenders will also evaluate the property you hope to buy. While some loans, such as FHA or VA, have their own unique requirements for the dwelling, land, and community of a property, most lenders will weigh the property’s actual value against the loan amount you are requesting. This loan-to-value (LTV) ratio ensures that they don’t loan out more money than a property is worth.
Lenders calculate the LTV by having a third-party appraiser evaluate the property and determine its current market value. Once you factor in not only the asking price of the home, but also any additional fees, closing costs, or other potential expenses, you may find that the loan you are requesting exceeds the actual value of the property you wish to buy. This scenario is a problem for lenders, who rely on the property as collateral in case a borrower defaults on their loan. For this reason, and depending on the lender or loan type, lenders may require you to provide a specific percentage of the purchase price as a down payment.
BONUS TIP: What Is PMI?
Private mortgage insurance, or PMI for short, is a type of insurance that protects a lender against default risk. Lenders will require homeowners who put down less than 20% of their home’s value to add PMI to their mortgage and will likely offer a higher interest rate. PMI can also increase your monthly payments. One of the great benefits of refinancing a mortgage is that it can enable a borrower to eliminate PMI from their monthly payments if they’ve paid off more than 20% of their home’s value.
Improve Your Chances of Qualifying for a Mortgage
There are different requirements for different mortgage types. Once you’ve done your research and decided what type you want to apply for, there are steps you can take to increase the likelihood of being approved when it comes time to apply. We’ve broken it down by the different stages of the home-buying process.
As You Begin the Home Search
Before you start your search for your dream home, there are a number of steps you should take. Completing the items below will help you determine the right price range home and enable you to shop with confidence when the time comes.
1. Analyze Your Finances
You know your finances better than anyone, so start by taking a long, hard look at your income, debts, and assets. Gathering this information and tracking down your accounts early on will help you you confidently produce the needed paperwork when lenders request verification later on in the process.
2. Calculate a Monthly Payment You Can Afford
Next, take a look at your household budget, and determine a monthly payment you can realistically afford. A good starting point is to keep your monthly mortgage payment below 28% of your gross monthly income, but it’s important to weigh your other expenses against your income to determine if you can afford that amount.
As you calculate a potential monthly payment amount, account for additional costs beyond the principal of your loan. The associated costs for your monthly mortgage and escrow payments will likely include:
- Interest Payments
- Property Taxes
- Home Insurance
- Flood Insurance
- HOA Fees
3. Understand the Different Loan Types
Depending on factors such as your income, credit score, military status, down payment amount, and where you live, you could have many different loans to choose from. Not all lenders offer all loan types, so you should begin your research early to determine the loan you may qualify for that aligns best with your budget and other financial goals.
Pro-Tip: If you are a first-time home buyer, your best match may well be an FHA loan. The U.S. Federal Housing Administration (FHA) insures these loans with favorable terms for the average home buyer.
4. Get Pre-Qualified for a Mortgage
After you've determined your preferred mortgage type, it's time to select a lender. Prospective lenders may offer different types of loans, so we generally recommend choosing someone local who has existing relationships and experience in your area, who also also offers the type of mortgage you've chosen. Once you’ve decided who you’d like to work with, it’s time to begin the loan application process.
Contact your lender about getting pre-qualified. They will need some basic information about things like your credit score and income, but a pre-qualification is a conditional agreement that can be modified as new information arises. The true purpose of pre-qualification is to give you an estimate of the amount you will likely be able to borrow. Once you know this, it’s time to begin your home search!
Pro-Tip: Once you begin viewing homes and interacting with realtors, prospective sellers and even builders are likely to encourage you to finance in-house with them or with organizations with whom they have relationships. They may even offer you incentives to do so. We recommend standing firm with the lending company of your choosing and, later in the process, trying to negotiate some of those same incentives for yourself.
When it’s Time to Make an Offer
Armed with your pre-qualification and an understanding of your own financial health, you should feel confident as you shop for the right home. At this point, your lender will ask for all of the documentation needed before finalizing your loan application and generating a pre-approval letter. You’re almost ready to make a formal offer on a home!
1. Gather Your Documents
Even though you’ve already been pre-qualified for a loan, there’s more to be done before your application can be marked as complete. At this stage of the process, lenders will verify aspects of your finances, including determining your actual credit score and requiring the following financial documents:
- Pay Stubs
- Employment Verification
- Financial Statements for all Accounts
- Personal Tax Returns
- Business Tax Returns (if applicable)
2. Receive a Pre-Approval Letter
Once your lender has verified the criteria above, they may be prepared to give you a pre-approval letter. Similar to pre-qualification, this will provide you with a reasonable price to keep in mind as you continue your home search. Because it is based on your recent financial documents and current credit score, your pre-approval letter may reflect a different amount than your original pre-qualification.
3. Start Your Home Search
By this point, you’ve probably already looked around and gotten an idea of what’s available in your market. However, now you are no longer “window shopping,” so to speak, but actually preparing to make an offer.
Once you’ve received your pre-approval letter, you will be regarded as a serious buyer. Your pre-approval letter translates to buying power, so this is the time to begin negotiating with sellers or realtors. Once you’ve found the right deal on a home you love, it’s time to submit a formal offer.
Once Your Offer Is Accepted
Congratulations! You’ve submitted an offer, and the seller has accepted. So what’s next? The work is not quite done. Here are the final steps you'll take to ensure that your mortgage is approved and, ultimately, funded. This stage concludes with you receiving the key to your new home!
1. Submit Your Formal Loan Application with Updated Documents
With your purchase agreement in hand, you can then fill out and submit your loan application. Often referred to as mortgage processing, at this phase your loan officer will work with you to gather the most current version of your financial documents, such as financial statements, tax documents, and pay stubs.
Pro-Tip: To help keep things moving smoothly, create a file of your own financial records and update them as soon as new documents become available. This ensures that you are always able to quickly provide the most up-to-date versions promptly.
2. Lock in Your Rate
Mortgage rates are always fluctuating, so it’s important to ask that your lender lock in your interest rate to avoid the possibility of it rising before your closing date. Many lenders will charge a fee to lock in your rate, but there are others, like First Service, who will allow you to lock your rate at no additional cost. This is something to consider early on when your lending partner.
3. Await Your Lender’s Due Diligence
By this time, you’ve already provided the documentation, and the lender should have everything they need to make a final determination on your loan. As a part of their due diligence, your lender will have the property appraised by a professional, independent third party to help verify the home’s LTV. As long as everything checks out, your loan will move to underwriting.
Pro-Tip: If the home you desire receives an appraisal below its asking price, you will quickly need to renegotiate the price with the seller. Otherwise, your loan is at risk of being cancelled by the lender.
Underwriting is the final stage of loan approval where final document review and verification takes place. You may be asked to submit additional documents after your loan goes to underwriting, and the underwriter will approve or deny your loan based on the information they receive. Once your loan makes it through the underwriting process, a closing date is set. At closing, you will meet with legal representatives to sign mortgage documents, pay any required closing costs, and receive your new keys.
How to Avoid Speed Bumps in the Mortgage Application Process
While the process is nearly identical for virtually all lenders, you may encounter some obstacles along the way. If you receive a lower than expected pre-qualification letter or even get denied for a home loan, don't give up hope. There are a few common reasons the mortgage process doesn’t always go as planned. These tips will help you steer clear of these speed bumps.
Low Credit Score
A low credit score can discourage a potential buyer from trying to purchase a home. If this is a concern for you, here are a few ideas for improving your credit score.
Additionally, you can help offset a low credit score by adding a co-borrower to your loan. If possible, look for someone close to you who may be willing to help by signing on as a co-borrower. Your lender will be more likely to approve the loan based on their higher credit score or larger income. And, of course, there is also the option of applying for an FHA loan, which requires a minimum credit score of just 580.
Pro-Tip: Do not apply for any new credit or do anything that could cause drastic changes in your finances throughout the entire application process. Major changes or additional credit inquiries can signal red flags to potential lenders.
Questionable Employment History
A prospective lender is going to carefully consider your employment history as a part of your mortgage application. The first step to overcoming the objection of a less-than-perfect work history is to provide documentation. If you can produce pay stubs, tax returns, W-2s, 1040s, or other forms that show income, you may be able to convince a lender to overlook gaps in your employment. If you don’t have such documentation, you may need to wait until you have at least two years of employment history working at the same job or consider adding a co-borrower with a more extended work history.
Pro-Tip: It can sometimes be difficult for self-employed borrowers to be approved for a mortgage, because most lenders want to see at least two years of consistent income. At First Service, we offer flexible mortgage options for entrepreneurial borrowers, so they can realize the dream of home ownership.
No Money for a Down Payment
Some lenders may ask you to verify down payment funds before they approve your loan. The exact amount will depend on your final loan type and amount. Fortunately, there are a few things you can do if you don’t have the money for a down payment.
- No-Money-Down Loans: Certain loan types, including USDA and VA loans, do not require a down payment. However, not every borrower or home will qualify. Your lender will help you determine if these loans are suitable for your situation.
- Down Payment Assistance: Many states, nonprofits, and even employers offer down payment assistance programs to encourage home ownership. Such programs usually provide zero-interest loans that may even be forgivable when certain requirements are met.
- Gift Money or Loan: As a borrower, you have the option to receive your down payment funds from a friend or family member in the form of a gift or loan. While many first-time homebuyers use this option, your lender will require documentation of the gift or loan. If you receive the money as a loan, the repayment terms may affect your debt-to-income ratio.
Unable to Afford Closing Costs
In addition to your down payment, there will be some additional closing costs you will need to pay before your loan can be funded. These costs vary, but can be as high as 6% of the home's purchase price. Similar to the down payment, borrowers have options at their disposal to covers these costs:
- Ask the Seller: Submitting your offer is the start of the negotiation process. As a part of this process, you can ask the seller to cover closing costs, or at least to contribute a certain amount towards them.
- Look for Grants: You may qualify for local grant programs or forgivable loans offered through a local community or government organization. Do your homework to find out if such programs are available in your area and, if so, what is required of applicants. Your realtor may be able to help you with this.
- Roll the Costs: Some lenders will offer a rebate that can be applied to your closing costs in exchange for a higher interest rate. This is not ideal, as it could add thousands of dollars to the total cost of your loan over its lifetime. However, in some cases it may be necessary. Fortunately, you may be able to refinance your loan at a later date to eliminate at least a portion of the extra cost.
How to Get Started with First Service
We’ve created this guide because we want to help you get into your dream home. Applying for a mortgage can be a long, complicated process, but having the right partner makes all the difference. At First Service, we are committed to helping our members understand the process. We are here to answer questions and, ultimately, help you get a mortgage that works for you.
If you’ve ready to make a move, we want to help. Complete the form below to speak with a local, knowledgeable mortgage advisor who is dedicated to making your dreams a reality.