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Your Credit Score Affects Your Eligibility

It’s no secret that the first thing most lenders look at is your credit score. This is a snapshot of your financial responsibility. A high score generally means that you are financially responsible. In other words, you don’t overextend yourself and you pay your bills on time. A low score generally means that you are financially irresponsible. You may pay your bills late or your overextended yourself, making it hard to keep up with your bills.

Each loan program and lender has their own credit score requirements. In general, you can expect the following requirements:

Conventional loans – 680 minimum credit score

FHA loan – 580 minimum credit score

VA loan – 620 credit score

USDA loan – 640 credit score

Each lender will have their own minimum requirements, but these are the industry standards. As you shop around, you may find that different lenders have higher credit score requirements, especially for FHA loans.

Your Outstanding Debt is a Factor

How much debt you have outstanding know affects your debt ratio. Your debt ratio is one of the largest factors in figuring out your mortgage eligibility. The more money you already have committed to previous debts each month, the higher your risk of default on a mortgage becomes.

Each loan program has their own debt ratio guidelines, but as a general rule, the total debt ratio cannot exceed 43% for any loan. The total debt ratio includes all of your monthly debts, such as car loans, student loans, and credit card debts as well as the proposed mortgage payment.

The various loan program debt ratio requirements include:

Conventional loan – 28% housing ratio and 36% total debt ratio

FHA loan – 31% housing ratio and 43% total debt ratio

VA loan – 43% total debt ratio (they don’t monitor the housing ratio)

USDA loan – 29% housing ratio and 41% total debt ratio

Again, each lender will have their own requirements. In order to lower your debt ratio, it’s a good idea to pay debts down or completely off if you can.

Your Down Payment Affects Your Chances

The more money you borrow in relation to the home’s value, the riskier you become. Lenders look at what they call the loan-to-value-ratio. In other words, how much money do you borrow compared to the home’s value? The more money you put down on the home, the less risk you pose to the lender.

You decrease your LTV by making a larger down payment. Conventional loans are known for their 20% down payment requirement. This is the point where you do not have to pay Private Mortgage Insurance because lenders feel this is enough ‘skin in the game’ to make you stay on top of your mortgage payments. If you put less than 20% down, the PMI covers the lender should you default.

Government-backed loans require little to no down payment, but it may still affect your approval. If you have a low credit score, high debt ratio, and no down payment, many lenders will likely consider you ‘high risk’, which could affect your mortgage eligibility.

Your Employment History Counts Too

Finally, lenders look at your employment history. The industry standard is two consecutive years at the same job. This shows the lender that you are consistent and reliable. What if you change jobs before you hold a job for two years? Are you instantly ineligible?

Today the 2-year history isn’t mandatory, but it’s still desired. The longer your employment history, the more the lender can rely on your ability to stay consistent with your job/income. This helps the lender feel good about the fact that you will be able to make your mortgage payments and won’t make rash decisions, leaving your job and putting your mortgage at risk of default.

Lenders put all of these pieces together to determine your loan eligibility. One ‘bad’ factor won’t automatically disqualify you, just as one ‘good’ factor won’t automatically make you eligible. Make your loan qualifying factors as good as possible in order to provide lenders with the picture that you can and will make your mortgage payments on time for the best chances at approval.

It’s getting harder to find a low interest rate today. That’s not to say rates are increasing astronomically. But, they are steadily getting higher. That low mortgage rate you could once get is not as easy today.

Make Sure You Have Good Credit

Lenders look at your credit first, plain and simple. It doesn’t matter which lender you go to, they look at your credit. Making yours as strong as possible can help you secure a lower rate. The higher your credit score, the less risk you pose. This may mean a lower interest rate.

Start fixing your credit long before you apply for a mortgage. Even if you haven’t pulled your credit, make sure you pay your bills on time. This practice alone can have a huge impact on your score. You should also try minimizing your total debt load.

Perhaps, most important is the need to check your credit report for errors. You won’t know if something erroneous is reporting unless you pull your credit. Each bureau allows you 1 free credit report per year. Take advantage of it and fix any errors you see.

The more steps you take to improve your credit score, the lower the interest rate many lenders will offer.

Keep Your Debt Ratio Down

Another large factor in your interest rate is the debt ratio. The more debt you have outstanding, the riskier you are to a lender. Take a minute to figure out your debt ratio.

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Total up your monthly obligations that report on your credit report. Things like car payments, credit cards, and student loan payments must be included. Then include the potential mortgage payment. If your total debt ratio exceeds 43%, you may not be eligible for a low interest rate. You may also have trouble finding a lender that will approve your loan.

In order to lower your debt ratio, you may need to pay debts off completely. In some cases, though, you may be able to pay them down. Credit cards are a good example. If you pay the balance down, your minimum payment decreases. This helps decrease your debt ratio. If your ratio is near the maximum, this could help tremendously.

Take Out an Adjustable Rate Mortgage

Sometimes even though you have great credit and a low debt ratio, you still get a high rate. It’s just the way the market goes. Taking out an ARM or adjustable rate mortgage can help, though. This method isn’t for everyone, so proceed with caution.

An ARM offers a low “teaser” rate. The term you choose determines how long you keep that low rate. It may vary from 3-10 years. After that time, the rate adjusts. You can’t predict how much it will change, though. This is why it’s not for everyone.

Borrowers who are in the home temporarily often do well with an ARM. If you can take one out that doesn’t adjust before you move, you luck out. Even if it does adjust while you are there, you have the option to refinance. It’s a gamble, but it could be worth it if you save enough money during the teaser rate years.

Pay for a Low Interest Rate

Some lenders allow you to “buy” your rate down. Essentially, you prepay interest. You just do it in percentage points. One point equals 1 percent of your loan amount. On a $100,000 loan, one point equals $1,000.

If you decide to pay discount points, the lender will lower your interest rate. Generally, one point lowers rates ½ of a point. Each lender decides just how much you’ll save, though. The more volatile the market, the more a discounted rate will cost you in most cases.

Make a Larger Down Payment

A larger down payment helps minimize the risk for the lender. It gives you what they call “skin in the game.” The more of your own money that you have invested in the home, the more likely you are to make your payments.

A borrower who puts down the minimum 5% on a conventional loan will likely get a higher rate than someone who puts down 20%, for example. Of course, this varies by lender and loan program. The larger the down payment, the more negotiating power you have with your lender. It also gives you leverage if you shop around.

Take a Shorter Term for a Low Interest Rate

Again, lenders like loans that aren’t risky. The longer you borrow money, the riskier you become. While lenders provide 30-year terms, they don’t prefer it. If you borrow money for 15 years versus 30 years, that’s double the amount of time. Granted, lenders make more interest, but their money is still at risk for another 15 years.

If you can swing it, opt for a shorter term. It doesn’t have to be as drastic as a 15-year term. You can try a 20 or even 25-year term. Any amount of time you can knock off the term helps your case, though. The shorter the term, the more likely you are to secure a low mortgage rate.

Compare Quotes From Different Lenders

This last tip is our favorite – shop around! Don’t take one lender’s word for it regarding what you qualify to receive. There are many fish in the sea, so to speak. Get out there and see what other lenders have to offer. We recommend shopping with at least 3 lenders.

Once you receive the offers, compare the Loan Estimate from each lender. This gives you a chance to see what they have to offer. Compare not only the interest rate, but also the fees. Look specifically for discount or origination points. Also, look at the APR to see what the loan will cost you over its entire life.

In a world of rising interest rates, you don’t have to settle. There are still ways to get a low interest rate. You’ll have to work at it, though. Make sure your loan application is as attractive as possible. Also, make sure you shop around and opt for the lowest term that you can afford. In the end, you’ll come out with the lowest rate available to you.

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The Biggest Factors That Affect Your Mortgage Eligibility