Buying a home can be a tricky process. Despite this, many people rush into it without knowing the full picture. Sadly, this approach often leads to disappointment as lenders turn them away.
Failing to secure financing could rudely shake you awake from the dream of becoming a homeowner. So, what can you do to make sure your loan application is approved? Below are six tips to help you along the way.
1. Understand Your Credit Report
All loan applications begin with your credit report and, these days, the requirements for a mortgage are stricter than ever. It’s important to know what lending institutes are looking for when they delve into your credit report. If you’re able to think like a lender, the battle is half won.
When a lender looks through your application – and, consequently, your credit report – they’re looking for several things. First, they want to know that your debt-to-income ratio is balanced, but they’ll also review your history – taking note of late or missed payments, bankruptcy, etc. Additionally, they’ll consider the various lines of credit you currently have open.
You can pull your credit report for free once per year (or pay to see it more often). It’s important to review it before applying for a loan, as you might find that there are issues you need to address. Also, it’s not uncommon for there to be errors in credit reports; these can usually be resolved, although it can take a few weeks.
2. Improve Your Credit Score
Once you’ve seen your report and checked your score, you might find that you need to improve it. Generally, the minimum for a conventional mortgage is a credit score of 620 (or 500 for an FHA loan). However, most lenders prefer a higher score, and many refuse to approve applicants with scores below 680. Essentially, the higher your credit score, the better the terms of your mortgage will be through lower interest rates, for example.
If you need to raise your score, it’s important to reduce your current debt. Ideally, your total monthly debt payments shouldn’t exceed 36% of your monthly income. If they do, it’s imperative that you start paying it off. Large auto loans and student debts will restrict how much you can borrow for a mortgage; so, if possible, reduce these first. Be sure to keep up with other bills, as well, and avoid late or missed payments. At the same time, keep any credit card balances manageable, and close any lines of credit that you don’t need.
3. Document Your Finances
Furthermore, when you apply for a loan, potential lenders will want to see proof that you’ll be able to pay it back – and that you’ll do so in a timely manner. As such, in addition to reviewing your credit report, they’ll also want to see your financial documentation. This includes proof of employment for a period of at least two years (preferably from a consistent employer), recent pay stubs, and tax returns from the last two or three years.
A steady income is the backbone that supports any loan; without proof of earnings and employment, it can be difficult to get approval. Plus, any cash given as a gift (from another family member, for instance) must also be properly documented so as not to appear as another loan – which would skew your debt-to-income ratio.
4. Have Cash in the Bank
Even if you have an excellent credit score and proof of a steady income, you still might be denied a mortgage if you don’t have any cash in the bank. Lenders will seldom approve an application if you can’t prove that you have the funds for a down payment. In fact, most lenders require a minimum 3.5% down payment, although the higher the better – for you and the lender; the more cash you can pay upfront, the lower your monthly repayments will be. In particular, down payments of 20% or more will also further reduce your monthly payments by avoiding the compulsory private mortgage insurance (PMI).
Plus, there are other costs that you’ll need to pay upfront, such as numerous closing costs. These may include, but aren’t limited to, agent fees, legal fees, home inspection, appraisal, and moving costs. Be sure to factor these in; if you’re unable to pay them, your application will be rejected.
5. Get Pre-Approved
The best way to set a realistic budget when planning to buy a home is to get pre-approved for a mortgage. To do so, you’ll need to apply with a lender and submit the documentation mentioned earlier to allow the lender to access your credit report. Then, they’ll analyze how much you can borrow, as well as how much cash you should be prepared to put down.
When you’re pre-approved, you’ll have a maximum budget to work with, which will help you search for homes that you can realistically afford. However, it’s wise to leave some leeway, as opposed to searching for properties at the upper limit of your budget.
Moreover, being pre-approved for a mortgage also puts you in a stronger position as a buyer, as sellers are far more likely to accept offers from buyers who have proven that they can obtain the necessary financing. But, pre-approval is not a guarantee of a loan, and applications can still be rejected at the last minute.
6. Keep Things Stable
To avoid falling at the last hurdle, keep your finances stable during the process of purchasing a new house. If possible, don’t leave your job, take out new lines of credit, or make large purchases on your credit cards. If you do, this will change your circumstances, and you may no longer be eligible for a loan.
Your approval is primarily based on your debt-to-income ratio. Anything you do to alter that ratio during the period between getting pre-approved and closing the deal can slow the process considerably – or even lead to your loan being rejected.