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What Factors Do Mortgage Lenders Consider?

You've found your dream home and you're ready to make what's probably the biggest purchase of your life. While a lucky few can pay for a home with cash, most of us will have to obtain a mortgage from a lender.

But what do you need to qualify for this huge loan? When reviewing a mortgage application, lenders look for an overall positive credit history, a low amount of debt and steady income, among other factors.

What Do Mortgage Lenders Look for on Your Credit Report?

Financial institutions will closely scrutinize your credit report when reviewing your application for a mortgage loan. While they look at your credit score, they also dive much deeper. Here are some of the things lenders will consider:

  • Recent applications: Lenders take a look to see if you've recently applied for any other forms of credit or debt. These applications cause what are called hard inquiries on your report, too many of which can look risky since a flurry of applications for new debt can indicate financial trouble.
  • Payment history: Lenders also will review your payment history on credit cards, loans, lines of credit and anything else that shows up on your credit report. They want to make sure you have a track record of on-time payments that could indicate you'll be a responsible mortgage borrower. If you have any old payments that were late or missed, the lender may ask you for an explanation.
  • Credit utilization: Your credit utilization ratio is a factor mortgage lenders consider. This ratio indicates how much of your available credit you're using at a given time. If you're using too much of your credit, it can make you appear overleveraged, and thus riskier to lenders. Most lenders prefer your credit utilization be under 30%, so make sure you're not exceeding this to see a positive impact on your credit scores and mortgage approval chances. In other words, if you have a credit card with a $10,000 limit, aim to keep your balance under $3,000.
  • Major derogatories (such as bankruptcies): This includes any negative mark that makes you look riskier as a borrower. This could be a bankruptcy, judgment, delinquent account, account in collections, charge-off or an account settled for less than what was owed.
  • Being an authorized user: When you're an authorized user on someone else's credit card account, it typically shows up on your credit report. The primary account holder's activity is reflected on your credit, so if they've used the account responsibly, it can help make your credit look better. However, your lender may not view this activity as a good way to assess your finances since you're on someone else's account, which doesn't necessarily represent how you'd handle a mortgage. Generally, lenders will consider accounts where you are the primary account holder much more heavily.
  • A dispute statement: Mortgage lenders will also check to see if there are any dispute statements or pending disputes on your credit report, and may look upon them negatively. Also, a dispute can hold up the mortgage underwriting process from a logistical standpoint. If you have a pending dispute on your credit report, it's advisable to wait for the dispute process to resolve before you apply for a mortgage. Lenders prefer to see a true view of your credit, without a pending dispute clouding the picture.

How Do Lenders Assess Your Income?

Your income is a major factor when it comes to being approved for a home loan. Mortgage lenders prefer borrowers who have a stable, predictable income to those who don't. While they look at your income from any work, additional income (such as that from investments) is included in their assessment.

Your debt-to-income ratio (DTI) is also very important to mortgage lenders. It indicates how much of your monthly income goes to your debts, and gives lenders an overall sense of how you're doing financially. If your ratio is high, it can show you're overleveraged and possibly not in a position to take on more debt, so you might face a higher interest rate or be denied altogether.

Keep in mind that the income and employment you indicate on your application is often verified, so use accurate information. Lenders will likely view your income documentation and may even directly contact employers for verification.

Do Mortgage Lenders Consider Your Assets?

While not as critical as your credit or income, lenders will usually want to see your bank statements. On your application, you can also list assets such as cash (things like checking accounts, savings accounts and CDs) and investments (retirement accounts, stocks, bonds or anything else).

Having high-value assets makes you look less risky to lenders. This is because they may mean you're better equipped to make a larger down payment and pay your mortgage payments on time every month, even if an emergency arises or you lose your job.

What Do Lenders Require for a Down Payment?

The rule of thumb is to try to save at least enough to make a 20% down payment on a home. A down payment of this size will get you closer to the best loan interest rates, but some conventional loans have much lower down payment requirements.

Depending on your situation, you may be eligible for a government-backed loan that allows you to put down very little. For example, a mortgage loan through the U.S. Department of Veterans Affairs requires nothing down, and loans through the Federal Housing Administration (FHA) permit as little as 3.5% down.

However, the higher the loan-to-value ratio (LTV) on your loan, the more risk you're asking a lender to take on. For example, if the LTV is 90%, it means the lender is financing 90% of the home's appraised value, while you, as the buyer, are putting down 10%. When the LTV is high, the lender is taking on a high proportion of the debt, and might require you to have private mortgage insurance (PMI) to offset its risk.

If you take out a conventional loan and put down less than 20%, you'll probably get stuck with a higher interest rate, and you'll likely be required to pay PMI until you reach 20% equity. With an FHA loan, you often have to pay mortgage insurance for the life of the loan.

Keep an Eye on Your Credit

As we mentioned, your credit report is one of the most crucial things mortgage lenders review in the underwriting process for loans. If you're not sure where your credit stands currently, check your free credit report on Experian to see how you stack up and where there's room for improvement.