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Most Important Factors to Getting Approved for a Mortgage

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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When David Inglis and his wife decided to move to San Diego last year, they were expecting a relatively smooth process. They’d keep the house they owned in Los Angeles and rent it out as a source of passive income, then they’d buy a new house in San Diego. They even had a 20% down payment ready to go.

“The problem was that we found renters and had to get out of our current house and close on the new house within 21 days,” Inglis, 40, a yacht broker, tells MagnifyMoney. That gave them just 21 days to get a mortgage — easier said than done. As Inglis put it: “Getting approved for a mortgage is a process, to say the least.”

With what felt like a moment’s notice, the couple had to gather up and submit everything from tax returns to current income statements, and do mountains of paperwork in between to get pre-qualified for a loan. From there, their lender picked through their credit scores, debt-to-income ratio, employment history — you name it. They closed on their new house in the nick of time at the end of 2017, and it was anything but a stress-free experience.

If you’re new to the whole buying-a-house thing, locking down a mortgage loan isn’t something that happens overnight. That’s not to say it isn’t worth it though. One recent Value Insured survey found that the vast majority of younger folks—a whopping 83%, in fact—still associate buying a home with the American dream.

At the starting line? There are a number of important factors that go into determining if a lender will approve you for a home loan. Here’s everything you need to know.

Getting approved for a mortgage — 5 things lenders are looking for

Credit score

Remember: A mortgage is a type of loan. When you’re applying for any type of financing, your credit score is perhaps the most important piece of the puzzle. This three-digit number essentially provides lenders with a general idea of your creditworthiness.

If you have accounts in collections or a history of making late payments, for example, you’ll have a lower-than-average score, which directly affects your loan options. That means you could get hit with higher interest rates or bigger mortgage insurance premiums, or both.

“Your credit score is really important on conventional loans,” John Moran, founder of TheHomeMortgagePro.com, tells MagnifyMoney. “Some other loan programs are less credit-sensitive.”

For conventional home loans, Moran says your credit score has to be at least 620, but for FHA or VA loans, you may be able to get away with a score in the 500s. But it’s not just about getting approved. The lower your score, the higher your mortgage rate will likely be — and that can add tens of thousands of dollars to the cost of your loan over time.

FICO, America’s leading credit reporting agency, looks at several important factors when determining your score. Your payment history, amounts owed, and length of credit history are chief among them. If you’re aiming for a home in the next year or two, you’ve got time to improve your credit if you start now.

Trust us — it’ll be worth the effort. You can see below what estimated mortgage rate folks would get based on their credit score and how much it could cost them over time. For our purposes, we’ll assume they’re all getting a $250,000 30-year fixed rate loan.

Score Range

APR

Monthly Payment

Total interest paid

760-850

3.914%

$1,181

$175,224

700-759

4.136%

$1,213

$186,760

680-699

4.313%

$1,239

$196,072

660-679

4.527%

$1,271

$207,462

640-659

4.957%

$1,335

$230,777

620-639

5.503%

$1,420

$261,180

Source: Calculated using the MyFico Loan Savings Calculator
Rates current as of Feb. 2, 2018.

You can find a detailed breakdown of your credit score by pulling up your credit report for free. Your report unpacks your credit history for lenders, so it’s vital to know what’s on it. This is crucial because you could end up spotting an error that’s weighing your score down.

If your credit score could use some work, don’t fret—there are plenty of ways to give it a good boost before buying a home. Establishing credit history, keeping your credit utilization ratio below 30%, and making consistent on-time payments are all on the list.

Debt vs. income

Your credit score goes hand in hand with your current debt load. Lenders specifically zero in on how your debt relates to your income. Together, this determines what’s known as your debt-to-income ratio (DTI)..

To calculate out your DTI, it’s fairly simple: Add up all your monthly debt obligations (not including your current housing payment unless you own the home and plan on keeping it), then divide that number by your gross monthly income. So if you pay, for example, $2,000 a month toward debt and you’re grossing $4,500, your DTI comes in at about 44%.

What’s a good DTI? Strive for 36% or less.

Fannie Mae, which sets the lending standards for the vast majority of mortgage loans, generally requires a maximum total DTI of no more than 36%. However, if the borrower meets certain credit and reserve requirements, they can generally get away with 45%.

Why? A high DTI is a red flag to lenders that you may not be able to afford a new monthly loan payment. In a lot of ways, it’s more telling than your credit score.

“The only thing that really matters to lenders is how this new monthly payment and your other debts relate to your income,” said Moran. “One of the quickest ways people can turn things around is by paying down revolving debts like credit cards and lines of credit, which increases your available credit and decreases your credit utilization ratio.”

He adds that making a smaller down payment in order to pay down revolving debt might improve your chances of qualifying since doing so will boost your credit score relatively quickly. Knocking those balances down also lowers your monthly minimum payment, so you may be able to qualify for a larger loan. In other words, your DTI isn’t the end-all-be-all when applying for a mortgage loan, but it’s pretty important.

Down payment

Lenders also look at how much of a down payment you can make, which ties directly back into your debt-to-income ratio. According to Bob McLaughlin, director of residential mortgage at financial services company Bryn Mawr Trust, putting down a higher down payment makes you more likely to get approved since it essentially decreases the risk for the lender. As a result, better loan terms and interest rates will likely be on the table.

“If you have the ability to put 20% down, you also avoid having to pay private mortgage insurance, which makes it easier to qualify,” he said.

Another perk is that you’ll have more equity in your home as well as a lower monthly mortgage payment. But for many, saving for a 20% down payment is a serious barrier to homeownership. Not surprisingly, a 2016 report put out by the National Association of Realtors found that the average down payment for first-time homebuyers has fallen in the 6% range for the last few years. The good news is that according to Moran, you can still get approved with a lower down payment.

“You can put 0% down for VA loans, 3.5% for FHA loans and even as little as 3% for conventional loans,” he said.

“There are people all the time buying homes with these minimum down payments, but it really all boils down to what you’re comfortable with and the kind of monthly payment you can handle.”

FHA and VA loans are usually the first low down-payment loans that come to mind, but options like personal loans and USDA loans may also be worth considering. Just keep in mind that taking this shortcut could potentially translate to a financial burden — low down payments typically necessitate higher insurance rates and extra fees to protect the lender.

That said, lenders are really looking at your big financial picture, not just your down payment size. If you’re putting down less, but have a good score and a steady source of income, you’re much more likely to get approved for a mortgage loan than someone with a lower score and/or spotty employment status.

Employment history

Our insiders say that your income and employment history are just as important as your credit score, DTI and down payment size. Again, it all comes down to lenders feeling confident that you can indeed repay your loan.

“You have to fit the underwriting guidelines per your profession, and there is little flexibility there,” said McLaughlin.

Piggybacking on this insight, Moran says that the ideal situation is if you’ve worked for the same employer for two years and you’re salaried. The second ideal way to get the green light is if you’re an hourly worker who’s been with the same company for at least two years.

But all this begs one obvious question: What about self-employed folks? The freelance economy is growing rapidly. According to the latest Freelancing in America survey conducted by Upwork and the Freelancers Union, these folks are predicted to make up the majority of the U.S. workforce within the next decade. Moran says that for these workers to qualify for a mortgage, they’ll need to have a two-year work history.

Check out our guide on getting approved for a mortgage when you’re self-employed.

“It’s a little bit of a kiss of death to start self-employment right before applying for a home loan,” he said.

“Most lenders won’t approve you because they want to be sure you’ll be able to afford your new loan payment. The only way to really prove you have a steady income is with two years’ worth of tax returns.”

In rare cases, Moran adds, you may be able to get away with one year, but it’s not the norm. Things are different of course, for self-employed newbies who are applying with a spouse who works a steady 9-to-5, which could tip the scales in their favor. Again, it’s all about the big picture. That said, a new salaried position will typically erase doubts stemming from a spotty employment history, as long as you have about two months’ worth of pay stubs, according to McLaughlin.

Loan size

All the factors we’re highlighting here are interwoven. The size of the loan you’re applying for fits right in. The higher your loan amount, the higher your monthly payment, which impacts that all-important DTI.

This is why you may be more likely to get approved if you’re seeking a lower amount. But whether you’re looking for $100,000 or $400,000, it really boils down to how big of a monthly payment your budget can absorb. (LendingTree, which is the parent company of MagnifyMoney, has a Home Affordability Calculator that can help you figure this out.)

The general rule of thumb here is to keep your mortgage loan (including principal, interest, taxes, and insurance) at or below 28% of your total income. Moran has worked with ultra-conservative folks who like to keep that number at 25%, but he says it really varies from person to person.

“Some people like to travel and don’t want to be house poor; others are homebodies and just really want a nice house because that’s where they’re going to spend their time,” he said.

“It’s all a trade-off, but either way, lenders will only pre-qualify you for what they think you can actually afford.”

How to get preapproved for a mortgage

Pre-approval is a term you’re likely to hear in the home-buying process. This is when the lender takes into account everything from your credit score and debts to employment history and down payment size to offer you a maximum loan amount.

When you come to the table with a pre-approved offer of lending from a bank, you’re already way ahead of the competition. And this can really give you an edge. When you’re living in a metro where most people are coming with double-digit down payments and pre-approvals to boot, you’re competing with very attractive borrowers.

Pre-approvals will ding your credit score, but the hit won’t be too bad if you complete several mortgage applications over a short time period, like 30 to 45 days. Multiple inquiries should only count as one hard inquiry on your credit report.

A good rule of thumb is to get mortgage quotes before you apply for pre-approval. You can get quotes quickly from different lenders at LendingTree by filling out a short online form.

Included in a pre-approval letter will be the estimated loan amount you might qualify for and your estimated mortgage rate.

The pre-approval process is also meant to prevent you from making offers on homes you can’t afford. But this doesn’t mean you have to actually take out a loan for the full amount. Many choose to get preapproved for their top number, then dial back during negotiations.

Final word

When it comes to mortgage approval factors, there are a lot of moving parts. Far and away, your credit score and debt-to-income ratio carry the most weight for potential lenders. From there, your ability to prove that you’re steadily and reliably employed is equally important.

At the end of the day, all that really matters is that you’re applying for a loan that you’ll actually be able to repay hiccup-free. The larger your down payment, the better your odds—especially if it eliminates the need for PMI. Either way, it’s probably in your best interest to meet with lenders before you start house hunting.

“You don’t want to put the cart before the horse by going with a realtor to look at houses, only to fall in love with something you can’t afford,” added McLaughlin. “Your emotions can definitely make the mortgage application process more stressful, which is why it’s best to go through the prequalification process first.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Marianne Hayes
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Marianne Hayes is a writer at MagnifyMoney. You can email Marianne here

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Is Buying an Investment Property Right for You?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Real estate has always been a popular strategy for building wealth. Beyond amassing equity in the house you live in, you could possibly turn a profit by purchasing investment properties and charging others rent. In an ideal situation, an investment property could rise in value while renters foot the bill for the mortgage and even repairs.The good news for investment-property owners is there is money to be made in being a landlord. A 2018 study by apartment search website RENTCafé found that millennials alone spend approximately $93,000 in rent by the time they’re 30.

However, buying an investment property isn’t as easy as purchasing a house you plan to live in yourself. Not only are the loan eligibility requirements stricter, but you’ll likely have to come up with more cash. If you’ve been thinking about purchasing your first investment property, here are some factors you should consider first.

You may pay higher interest rates. Lenders charge higher interest rates when they believe there is a higher risk that the borrower will default. Investment properties are considered riskier than buyer-occupied homes because lenders figure people are likely to try harder to pay the mortgage on the home they live in than they would for an investment property if times get tough. As a result, the interest rates are typically a point or more higher for investment properties, said Rick Bettencourt Jr., a mortgage professional based in Danvers, Mass., and board president for the National Association of Mortgage Brokers.

Interest rates on multi-unit dwellings tend to be the highest of all. “Buying an investment property that’s a multi-family unit is the riskiest type of home loan that you can get,” Bettencourt said. As with other types of home loans, the lower your credit score, the higher the interest rate you’ll pay. Rising interest rates, such as in the current environment, will also likely have an impact on the buyer’s borrowing power. As mortgage rates rise, investment properties may stay on the market for a longer period of time, Bettencourt said.

You may need a larger down payment. When you buy a house that you plan to live in, many lenders let you put down less than 20% as long as you pay mortgage insurance. However, mortgage insurance is not an option for borrowers who are buying investment properties. Borrowers will typically have to put down 20% in order to be approved for a loan — and to get the lowest rates, expect to put down 25%, Bettencourt said.

You’ll likely need more in cash reserves. Not only will you need to come up with the cash for the down payment, but lenders also typically require investment property buyers to have enough stashed away to cover several months of mortgage payments. A good rule of thumb is to have six months of mortgage payments, so if your mortgage payment is $2,000, you’ll need $12,000 Bettencourt said. Assets held in checking and savings accounts, CDs, mutual funds and retirement accounts can all count toward your reserves.

Rental income may be included in your debt-to-income (DTI) ratio. Lenders will consider how much income you have relative to debt when determining whether they’ll lend you money and how much you will qualify for. They want to know that despite current debt obligations, you have enough money coming in to pay the mortgage. When you buy a rental property, lenders not only consider your current income, but they consider how much money you could potentially make charging rent. That means they calculate a higher income for you than you currently have, and as a result, you could likely qualify for a more expensive rental property than a house you intended to live in.

Your credit rating may be more important. Because lenders consider investment property financing a riskier type of loan, they’re going to be looking a lot harder at your credit score when determining whether to lend you money. To get the best rates, many lenders will look for a minimum score of 720, but if you can get your score in the 740 to 760 range, that would be ideal, Bettencourt said.

You may incur other costs. Don’t just consider the costs of buying the property — also factor in whether you’ll be able to maintain it. Could you afford the costs of hiring contractors when you need repairs? Have you considered the costs of property maintenance and utilities?
“If the cost to maintain the property is going to be expensive, that will eat into any of your profits,” Bettencourt said. Also, consider whether you’ll be able to pay the mortgage if you’re between tenants for a long period.

Financing your investment property

Once you’ve weighed these factors and decided that an investment property is for you, the next step is determining how to finance it. Here are some options to think about.

Conventional loans. If you have a high credit score and assets, a conventional loan could be your best bet. Keep in mind that conventional lenders likely will have the strictest requirements. For example, Wells Fargo requires borrowers to have two years of property management experience in order to use potential rental income to help qualify for the loan.

Home equity loan or HELOC. Depending on how much equity you have in your principal residence, you may be able to leverage it to pay for an investment property. One reason this may be a good option: Home equity loans and home equity lines of credit, or HELOCs, typically come with lower interest rates than investment property loans because they don’t carry as much risk. However, there’s always the risk that if your investment property struggles and you can no longer afford the payments, you could end up losing your house as well.

Financing through the seller. In some cases, owner financing may be available. With such an agreement, you and the seller would decide on the terms of the loan and you’d make payments directly to the seller rather than going through a traditional lender. Without a lender, the requirements may be less stringent and there may be less paperwork involved. If you finance through the seller, know that the transaction might not be on your credit report unless the seller reports it to a credit reporting agency.

Loans from private lenders or investors. If you’re looking for a loan with more flexibility, you may be able to get it by finding a private lender or investor who is willing to underwrite your deal. They may be more willing to negotiate with you about the terms of the deal than a traditional lender. Some peer-to-peer lending networks bring together borrowers with potential investors for real estate projects.

FHA loans and VA loans. Many homebuyers find loans backed by the Federal Housing Administration and the U.S. Department of Veterans Affairs appealing because they allow you to put down less than 20% on a property. FHA loans allow you to put down as little as 3.5%, while VA loans can be taken out with no down payment. For the most part, you can’t use FHA or VA loans for purchasing an investment property because they are designated for owner-occupied homes. But there is an exception: If you buy a house with up to four units and live in one of them, you may be able to satisfy that requirement.

Buying your first investment property can get you started on building your own real estate empire. But like all investments, real estate comes with risks. The housing market could crash or you could be stuck paying the investment property’s mortgage between renters. Before you make such a major investment, it’s important to consider how you would handle a downturn in the housing market or other potential challenges. If you do decide that buying an investment property is for you, do your research and ensure that your financing strategy will benefit you in the long term.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Tamara Holmes
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Tamara Holmes is a writer at MagnifyMoney. You can email Tamara here

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7 Tips for Taking Out a Home Equity Loan

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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If you are a homeowner looking to borrow a hefty sum, chances are you’ve already considered a home equity loan. Home equity loans are granted based on the equity value of your home — that is, the overall value of the property minus the amount owed on your mortgage.Tapping into this equity is a great way to get access to funds for large home improvement projects or financial needs like paying for college, but this option should be exercised cautiously. With your home as the main collateral, foreclosure becomes a serious risk if you fail to pay back your lender. As the borrower, it’s also important to fully understand your loan agreement before you sign, especially in today’s climate of rising interest rates and changing tax laws. Here are a few tips to get you started in the right direction:

1. Consider all options before taking out a home equity loan

Home equity loans are typically the first form of borrowing that comes to mind for homeowners, but it’s good to be aware of other options. Depending on your financial goals, a home equity line of credit (HELOC) might make more sense. Unlike the fixed sum of a home equity loan, a HELOC is a fluid line of credit that allows you to borrow what you want within a credit limit and pay back only what you borrow. It’s a good choice for people who want the option to borrow a large sum without necessarily commiting to the debt up front.

Just like credit cards, HELOCs vary drastically. According to the Consumer Financial Protection Bureau, they usually have a variable interest rate, but borrowers should make sure they understand all stipulations of the loan agreement before signing. These include when they can withdraw funds (ask about a minimum wait period and maximum draw period), additional closing costs and any minimum requirements surrounding the home’s value. If the value decreases significantly, lenders may choose to limit your credit line.

Other borrowing options for homeowners include cash-out refinancing and personal loans. Cash-out refinancing is meant for homeowners looking to lower the interest rates on their mortgage and gain access to additional funds. These typically make the most sense for borrowers who need a significant additional amount and should only be considered when the terms of the new agreement are better than those of the original mortgage.

Keep in mind that all of these borrowing methods put your home at risk and can include significant closing costs. If you only need to borrow a small sum on a short-term basis, you might be better off exploring your options with personal loans.

2. Know tax rules

The Tax Cuts and Jobs Act of 2017 understandably raises concerns for many prospective borrowers, but there are really only a handful of changes that relate to home equity loans and lines of credit.

The first revolves around paid interest and how you can deduct it from your taxes. According to the IRS, the new law states that interest paid on home equity loans and lines of credit is only eligible for deduction if the loans are used to “buy, build or substantially improve” the taxpayer’s principal residence. This means that you won’t be able to deduct interest on a loan used for something like college tuition.

Paid interest deductions are also limited now to homes with mortgages of $750,000 and less, but with the average 2018 new U.S. mortgage of $260,386, this cap isn’t likely to affect the majority of borrowers.

3. Know when long-term debt doesn’t make sense

Once again, home equity loans aren’t the right choice for every borrower. If you’re considering taking out a loan to finance something short-term, like a luxury vacation or clothing, you’d be better off looking into other options that don’t put your house at risk.

4. Know when long-term debt makes sense

Home equity loans and credit lines are better suited for borrowers looking to make long-term investments that add value to their property or create a higher earning potential for their household. This would include things like college tuition and remodeling projects.

5. Keep your total home loan debt below 80%

When it comes to deciding how much money to let you borrow, lenders use what’s called loan-to-value ratio (LTV), which is calculated by dividing the loan amount by the value of your property. While this term usually refers to mortgages, the numbers apply similarly to home equity loans and how much a lender will let you borrow.

In order to qualify for a home equity loan you should maintain a minimum of 20% equity in the home — or said another way, you should always keep your total loan debt below 80%. If your total loan debt exceeds 80%, your lender may ask you to take out private mortgage insurance (PMI). The amount you pay for a PMI will vary based on your LTV and credit score, but ultimately it’s something extra you’ll have to buy to protect the lender — not you.

Another reason to keep your total debt below 80% is to maintain a financial cushion in the event that you suddenly need to sell your home. Using the same logic as the lenders, this ratio ideally would allow you to cut your losses, even in the event that you were forced to sell at a lower amount or with outstanding debts to pay.

6. Shop around

Like anything else, the best way to get a fair loan agreement is to shop around. Ask friends for lender recommendations, and talk to as many of them as you can. Have them go over agreements with you and be sure you understand all of the terms, conditions and fees involved. Once you’ve received a few different loan plans, don’t be afraid to negotiate and make them compete for your business.

According to the Federal Trade Commission (FTC), lenders and brokers have been known to offer different prices for the same loan terms — often because they’re allowed to keep the difference. A good way to start the negotiation process is to ask a lender to write down all the costs of the loan and then ask them to waive or lower certain components. Use a sheet like this one to compare final terms and get the best deal.

7. Have a plan

Don’t wait until your loan agreement is signed to think about the repayment process. Your repayment plan will vary depending on the term and interest rates of your loan agreement. Generally, the longer the term of your loan (or the longer it takes you to repay it), the more you’ll end up paying. Save money on your loans by making a plan to pay them off as soon as possible. By contributing even a little more each month, you’ll end up saving a lot on interest.

Home equity loans are a good resource for homeowners in good financial standing who need funds for a long-term investment. But unlike other forms of debt, these loans could literally cost you your home, and should only be taken out with a solid repayment plan in place.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Larissa Runkle
Larissa Runkle |

Larissa Runkle is a writer at MagnifyMoney. You can email Larissa here

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