When you apply for a home loan, there are many things that affect your eligibility. Just having a great credit score or a low debt ratio isn’t enough. Lenders look at the big picture. It’s almost like a puzzle. They take each piece of the puzzle and put it together to figure out your level of risk. This means that negative factors can be offset by positive factors and vice versa.
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So what does a lender look at the most when deciding whether to approve you for a loan? Keep reading to find out.
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.
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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.