Purchasing a home is one of the biggest investments you will ever make. To ensure you can afford the mortgage, lenders evaluate a variety of factors including income and employment history, savings and debt payments, credit report and score, and assets.
Many of these factors can impact your ability to purchase a home and determine the interest rate you will receive. Here are 10 essential things to consider before getting a mortgage:
1. Your Credit Score
Your credit score is one of the most important factors when you want to work with a local lender when approving mortgages. It reflects your reliability as a borrower, and lenders may offer better terms to those with excellent scores.
Mortgage lenders look at a variety of factors in your credit score, including the length of your credit history, your payment history and how many types of credit you have. They also analyze your debt-to-income ratio, which shows how much of your monthly income goes toward paying off debt.
A good credit score ranges from 300 to 850. While each lender uses its own credit scoring models, they usually have similar elements in mind when considering your application. Your credit score is based on information found in your credit reports, and each report has different details about your financial past. Paying bills on time and lowering your credit utilization ratio can help you raise your credit score.
2. Your Debt-to-Income Ratio
Lenders will look closely at your debt-to-income ratio when deciding whether to approve you for a mortgage. This is a percentage that takes into account all of your monthly reoccurring debt payments (including credit card and auto loan repayments) as well as your projected mortgage payment and divides it by your gross income.
This will give lenders an idea of how much you can comfortably afford in debt payments each month. You’ll want to keep this number low, ideally below 36 percent.
A high DTI ratio can be a red flag for lenders and may result in your being denied loans or credit, or having less favorable terms when you do get approved. To improve your chances, avoid taking on new debt until you’re ready to apply for a mortgage. You should also try to pay down existing debt.
3. Your Down Payment
The size of your down payment plays an important role in your mortgage. Generally, home buyers need to make at least a 5% down payment in order to purchase their new homes. The larger the down payment, the lower the mortgage loan amount and thus, the lower your monthly mortgage payments.
Lenders like large down payments because they help to mitigate their investment risk by lowering the principal that they have to finance. It also shows them that the borrower is committed to their new home and less likely to default on their loan.
However, it’s important to consider the opportunity cost of putting so much money toward your down payment before you decide. That money may be better spent on long-term investments or retirement savings. Also, with low down payment mortgage options (like government-backed loans and conventional loans with as little as 1% down), you’ll usually have to pay for private mortgage insurance, adding to your overall costs.
4. Your Employment History
Your employment history is a record of the jobs you have held in the past. This information is important to lenders because it can help them determine your level of experience and stability. It can also help them assess your ability to repay a mortgage.
Most employers will require that candidates provide their work history on a resume or job application. This information usually includes the company name, job title, and dates of employment. It may also include any educational or training programs that the candidate has completed.
It can be difficult to find employment history, especially if you have worked in several different jobs over the years. However, there are a few ways to obtain it. One way is to contact the Social Security Administration and request your earnings information. This can be done for free, but it may take some time.
5. Your Credit History
Your credit history, as recorded in your credit report, is a big factor when it comes to mortgage lenders. Your credit history includes input on your payment behavior and the type of accounts you have, such as revolving and installment loans (auto, personal, student) and credit cards.
Credit reports, which are compiled by credit bureaus, are used by lenders to determine whether or not you’ll be approved for a loan or mortgage and on what terms. They also use them to make other decisions, such as offering you insurance or renting an apartment.
Lenders like to see a long and established credit history, as it indicates that you’re a responsible borrower who pays on time. It’s also best to avoid making many requests for new credit before applying for a mortgage, as this will hurt your score.
6. Your Income
Whether you are buying a home or refinancing an existing mortgage, you’ll need to consider your annual income. Lenders will only let you borrow the amount of money you can afford to repay without stretching your family’s other priorities too thin.
Lenders calculate your household income by examining your gross annual income, or the amount you earn before taxes and deductions. This figure includes salary, wages, overtime pay, tips and bonus payments. It doesn’t include investment or retirement income, as these aren’t part of your regular income.
A mortgage is an installment loan, meaning you’ll make monthly payments toward the principal and interest over a set period of time. Each payment will reduce the total amount you owe, and an appraiser will compare the home you’re buying with similar homes in the neighborhood to determine its value.
7. Your Credit Score
Credit scores play an important role in mortgage approvals and interest rates. But what’s considered a “good” or “bad” credit score can vary between lenders, because each has its own criteria for approving borrowers.
The highest credit score lenders usually consider acceptable is 800 or above, which indicates that you’re an exceptionally low risk as a borrower. But lenders may still approve borrowers with lower credit scores for certain types of mortgages, especially if they have a large down payment and a solid savings history.
To boost your credit score before applying for a mortgage, pay your bills on time and keep balances as low as possible. It’s also a good idea to avoid opening new credit cards, as doing so can impact your credit utilization ratio and lower your score.
8. Your Debt-to-Income Ratio
Your debt-to-income ratio is a key consideration when considering a mortgage. It is the percentage of your monthly income that goes toward paying off recurring debts, such as a rent or mortgage payment, auto loans and student loan payments. It does not include living expenses, such as food and utilities.
To calculate your DTI, add up the total of your recurring debt payments and then divide that amount by your gross (pre-tax) monthly income. This will give you a front-end DTI and a back-end DTI. Generally, lenders want to see a front-end DTI of 28% or less and a back-end DTI of 36% or less. But every lender has its own lending guidelines and mortgage programs. So, it’s important to speak with a loan officer who can help you understand how the different factors will affect your eligibility.
9. Your Down Payment
Lenders require down payments to mitigate their risk by ensuring that borrowers have skin in the game and that they’re less likely to default on their mortgage. Down payments also reduce the amount of principal on which you’ll pay interest, lowering your overall mortgage costs.
Historically, lenders have recommended that homebuyers make a down payment of 20% of the home’s purchase price. However, it’s not always necessary to make such a large down payment, and you should weigh the pros and cons of different down-payment amounts before making a decision.
In some cases, you can find loans that don’t require a down payment at all, such as FHA and Department of Veterans Affairs (VA) loans. But even with these options, you may still want to save up for a larger down payment and avoid having to pay monthly private mortgage insurance (PMI).
10. Your Credit History
Lenders rely on your credit history to determine whether you’re someone they can trust with a mortgage. This includes the number of credit-related accounts you have, the types of accounts (such as installment and revolving), payment history, how many times you’ve missed payments in the past, and outstanding balances on your accounts.
A lender will also look at the length of your credit history, as well as the total amount of debt you owe. They will be more inclined to lend to borrowers with longer and more diverse credit histories, as these borrowers are likely to pay back their loans responsibly.