With mortgage interest rates hovering between 3.5% and 4%, there has never been a better time to move up or jump into homeownership. The interest rate on your home loan dictates your monthly mortgage obligation, and when rates drop, you can lock in a low, affordable payment. But while low rates entice many to take out a loan, getting a mortgage approval is easier said than done.
The aftermath of the great mortgage crisis of 2007-2008 led to tighter lending guidelines, in which lenders went from one extreme to another. Anyone with a pulse could qualify for a mortgage before the crisis, whereas now you have to practically jump through hurdles.
Although tighter lending slows the path to homeownership – with mortgage lenders rejecting between 26% and 50% of mortgage applications – you shouldn’t let these figures scare you. The mortgage industry isn’t completely dead and many properties are sold each day.
To ensure a smooth, uncomplicated process, you have to know and give lenders what they want.
1. Get Your Credit Straight
Don’t even think about applying for a home mortgage loan with a credit score under 620. This is the absolute minimum to qualify for a home loan, wherein an FHA mortgage is your best bet. Conventional mortgage lenders require a credit score of 680 or higher, with a score of 720+ commanding the most favorable interest rates. Fortunately, there’s plenty you can do to give your credit a boost.
- Order your credit report from AnnualCreditReport.com and check for errors. Contact creditors to have errors removed from your report, or file a dispute with each of the three credit bureaus.
- Always pay your creditors on time. Late or missed payments can be the kiss of death when applying for a home loan, and many lenders only allow one 30-day late payment in a 12-month period.
- Pay off your credit cards and loans. This is by far the fastest and simplest ways to add points to your credit score. Even if you can’t pay the balance in full, start doubling or tripling your payments to widen the gap between what you owe and your credit limit.
- Read our Credit Score Blueprint
2. Get Your Documentation in Order
Lenders want to see proof (and more proof) of your financial history. This includes tax returns for the past two years, bank account statements and your recent paychecks. Yes, it’s a hassle to gather and make copies of these documents, but it’s necessary in order for lenders to assess your financial stability. Mortgage lenders will go to great lengths to avoid past mistakes, even if it means scrutinizing income records and denying otherwise qualified applicants for lack of financial documentation or gaps in their employment history.
3. Reduce Your Debt-to-Income Ratio
Paying down credit cards and loans not only give your personal score a boost, it also lowers your debt-to-income ratio and improves your odds of getting a home loan. Mortgage lenders factor in how much you currently owe. They’ll take the minimum payments for all your balances and weigh this against your gross monthly income.
As a rule, debt payments (including your home loan) cannot exceed 36% of your gross monthly income. This isn’t a hard and fast rule, and some lenders allow debt percentages as high as 41%. However, if you want to guarantee a home loan approval, pay down your existing debts and don’t take on new debts until after you’ve closed on your mortgage loan.
4. Save Your Cash
If you’ve never purchased a home, or if it’s been four or five years since your last purchase, you might not be up to speed with the latest cash requirements. Just a few short years ago anyone could walk into a mortgage lender’s office, sign their name and purchase a house with very little out-of-pocket. Maybe they paid cash for a home appraisal or a home inspection. But as far as down payments and closing costs, these were practically extinct. Lenders offered 100% financing, and when a seller didn’t pay a buyer’s closing costs, lenders simply rolled these fees into the loan.
Fast forward to present day and it’s a completely different story. Mortgage lenders no longer front the entire cost of a home purchase, but now require a minimum down payment between 3.5% and 5%. Yet, the costs don’t stop here. You also need money for your closing costs, which can fall between 3% and 5% of the purchase price. All in all, mortgage-related fees can run upwards of 10% of the purchase price.