Published September 30, 2013
Potential homebuyers who have found their dream home have cleared one hurdle in the current low-inventory housing market, but they still face another major challenge: securing a loan.
Many consumers are looking to take advantage of the low mortgage interest rates, but tight lending practices are making the home-buying process difficult as banks remain risk adverse in the wake of the financial crisis.
The mortgage process can be hard to navigate as most lenders require at least a 20% down payment and a high credit score. But there are steps consumers can take to better navigate the mortgage process and increase their chances of getting their dream home.
“Before people go out to look for homes, it’s important to get preapproved— trying to get the mortgage before you make the offer is a backwards way of doing things,” says Tony Garcia III, retail regional sales manager, Wells Fargo Home Mortgage.
Before approaching a bank or mortgage broker, be aware of your overall financial picture, and be ready with the necessary document like income stubs, W2s and bank statements.
“You want to be able to answer any questions before you make an offer [on a home],” he says.
Get Your Down Payment Together
There are down payment assistance programs that help customers who don’t have enough money saved to make the required down payment, according to Garcia. “Your city might have a housing foundation that gives money to people looking to buy homes in those cities.”
Federal Housing Administration loans are also available to buy a home and only they only require 3.5% down payments. “If you’ve been able to make your rent payment, you should be able to make a mortgage payment of the same amount,” says Frank Donnelly, chairman of the board of the Mortgage Bankers Association of Metropolitan Washington.
Aside from these programs, Garcia suggests taking advantage of online tools to help budget and save money for a down payment. “The less money you put down, your payment will be higher for that same loan,” he says.
Show Your Money is Seasoned
Having your money in your account for longer than 60 days is important. “If you made a large deposit, be able to show where the money came from,” says Garcia.
Lower Your Debt
Lenders are paying close attention to wanna-be borrowers’ debt-to-income (DTI) ratio when evaluating the risk behind a mortgage.
“Anything with monthly payments increases your monthly debt,” says Michael Corbett, Trulia's real estate expert. “Lenders check your credit when you start the process and before they close the loan.” Before making any large purchases before buying a new home, like a car, experts recommend talking to a mortgage professional.
There are ways to lower a DTI that’s too high, says Donnelly, with paying off debt being the main tactic. Consumers with high credit payments should consider consolidating and refinancing these loans to help lower monthly payments and ultimately a DTI.
Improve Your Credit Score
“Prior to the crisis, the average home buyer’s FICO score was about 30 points higher than the general public— now it’s about 70 points higher,” says Donnelly. Average FICOs for a purchase with a Fannie Mae or Freddie Mac loan was 763, while FICO scores for a FHA loan was 700, in August 2012.
Consumers need to review their credit report for an honest assessment of their financial situation. “There are many free services that will give you tips to help you understand and improve your financial situation,” says Garcia. Buyers should also check that there are no mistakes about late payments or bad information on their credit report.
Potential borrowers should avoid spending more than 50% of their credit limit and strive to make all payments on time, adds Donnelly. Don’t be too quick to close credit cards before a home purchase, having credit lines open a long time is preferential to ones that were opened recently.
Consumers with blemishes on their credit report like a foreclosure or short sale should know how these will impact their borrowing capability. “We’re coming out of a declining real estate mark et and many people went through [bankruptcy, foreclosure or a short sale],” says Cara Ameer, broker associate and Realtor at Coldwell Banker Vanguard Realty based in Ponte Vedra Beach, Fla. She says traditional waiting periods to qualify for a new loan can last anywhere between two years for a short sale or bankruptcy, and seven years for a foreclosure or deed in lieu on a primary residence.
“There could be many different reasons why someone had a short sale, foreclosure or bankruptcy and depending on that reason, they may still be able to qualify for a mortgage sooner than they expect,” says Garcia.
Prove Your Job Stability
“If you haven’t been in your job long enough or have gaps in employment, [lenders] want to see that you’ve been working at least a year,” said Ameer. Counsel with a mortgage professional if you’re in any of these categories.
Buyers who have changed professions, gone from a salary to a commission job, or moved and changed jobs at the same time, may face an uphill battle when apply for a mortgage. “The bank needs to see a history of your income and consistency,” says Corbett. “They need to see in black and white your earning potential.”
Individuals who have relocated for work should be sure to have their offer letter ready to show to a mortgage lender.
Earning money from interest in the bank or profit from rental property or a small business may make getting a mortgage challenging. “Be able to document all sources of income,” says Garcia.
People with a salary qualify for loans based on that number and a down payment, and self-employed workers may deduct unreimbursed employee expenses from their income, says Donnelly, and the number they give a lender should accurately reflect what the IRS has on file.
For people planning to include rental income, a lender wants the current residence to have a loan-to-value ratio that’s generally below 75%, says Donnelly, otherwise they’ll need to qualify for the payment of a new home and rental property.
“You can pay down the loan to [a loan-to-value ratio of] 70% or 75% or buy a new home where you can carry both payments.” To include this income, lenders want to see a security deposit from the lease, a lease and that you’ve been a landlord for two years on your tax returns.