Are you planning to buy a home or refinance the mortgage you have, but not sure you have what it takes to score a low interest rate?
It's a valid concern since lenders' requirements have changed in the past few years thanks to the challenging economy, says Chris L. Boulter, president of Val-Chris Investments, Inc., a California company specializing in residential and commercial loans.
"Now, because of the mortgage industry crisis a few years ago, there are fewer lenders and higher standards to qualify," says Boulter. He adds that, unlike a few years ago, lenders are now demanding proof of things like personal assets and years of employment.
What other factors are lenders looking at? Keep reading to find out…
Factor #1: Credit Score
Ever feel like you're just a number in a computer to creditors? Well, when it comes to qualifying for a mortgage, that number is your credit score.
While it's not the only thing lenders look at, Boulter says your credit score is the first and most influential thing lenders check when considering your qualification for a mortgage. Equally important, your credit score is also used to determine how low your interest rate will be.
"To qualify for the lowest rates, you need a minimum score of 720," says Boulter.
According to the Fair Isaac (FICO) scale, which Boulter says is the scale most banks use, the scores run from a low of 300 to a high of 850.
But what if you've had a few bad breaks and your credit score has suffered because of them? Don't worry. While you may not qualify for those news-making interest rates, you could still get a mortgage or refinance with a very good mortgage rate, says Boulter.
Factor #2: Income vs. Monthly Expenses
Even Donald Trump probably wants more house than he can afford. It's human nature. So it's your lender's job to make sure you don't get in over your head by borrowing more money than you can comfortably pay back.
To do that, says Boulter, most lenders use a simple calculation: Your total liabilities (monthly expenses) cannot exceed 40 percent of your gross income. Lenders call this the debt-to-income ratio, says Boulter, and it's nearly as important as your credit score.
And remember, if both you and your spouse work, it's both your incomes combined - and both your liabilities that lenders will look at.
So, what counts as a liability? Here's a list of common ones, according to Boulter:
- Mortgage payment
- Property taxes
- Homeowners insurance
- Condominium association fees
- Credit card payments
- Car insurance payments
- Alimony or child support
- Student loans
However, when it comes to your electric or cable bill, groceries, and life insurance…these are examples of things lenders figure you'll spend the other 60 percent of your income on.
Factor #3: Equity
Equity is the difference between the market value of your home (or the home you want to buy) and what you owe (or will owe) on your mortgage. It's important to know this definition as your equity has a big influence on whether or not you'll qualify for a low mortgage rate.
To get a good rate, says Boulter, your equity has to be 20 percent or more of the market value.
That's because when your home loses value, your equity is the first to take a hit. The more your down payment (equity) is, the less risk the lender has of losing money if home prices go down, says Boulter. In other words, prices would have to go down 21 percent before they start to lose money.
If you don't have 20 percent equity, you may still qualify for a mortgage, says Boulter. However, you will have to pay for private mortgage insurance (PMI), which covers the lender's losses if you stop making loan payments, according to the Federal Reserve System, which oversees national monetary policy and the banks. Their website estimates PMI to cost $50 to $100 a month
Factor #4: Job History
Have you had uninterrupted work for the past two years or more? Have you been in the same job, or at least the same industry? If you said yes, that's music to lenders' ears.
"Because of the high unemployment in recent years, lenders really want to see a stable job history," says Boulter. Typically, he says, they want proof of two years of employment in the same position or industry. And proof is not a nice letter from your coworker. It's pay stubs or tax returns.
If you've been a victim of the tough economy, however, and had to endure some unemployment, a mortgage isn't out of the picture for you just yet. You could still qualify, you may just have to pay a higher interest rate and show additional favorable qualities, such as excellent credit, more than 20 percent equity, or a lot of savings.
Factor #5: Assets and Savings
Have you ever had one of those months where it seems like the universe is against you? The car breaks down, your kid needs braces, an illness stops you from earning money? You're not alone. Bad things happen to good people all the time, and the bank knows that. That's why lenders want you to have some money stowed away for a rainy day.
"Usually, lenders want proof of four to six months of reserves that you can access in case something happens to hinder your income," says Boulter. The reserves - or ready money - has to be enough to cover your mortgage and bills if, say, you lost your job.
The best reserve is cash in a savings account, he says, but other forms of assets are acceptable, too. This includes liquid assets such as stocks or bonds, retirement accounts, or insurance policies - all of which could be converted into immediate cash.
What if you don't have the necessary assets? If all other criteria are met, from credit to equity, you could still qualify for a mortgage, but Boulter says lenders are probably not going to give you the best rate. In other cases, you may not qualify and will have to do what you can to build up your assets before reapplying.