Oh, sweet mortgage! You’re just a few mental jumps away from applying for a loan that’ll get you out of the apartment life forever and into a home of your own. Before you darken a lender’s doorstep, virtual or otherwise, you should really put a little effort into polishing your financial profile. After all, the better you look to your lender, the better odds you’ll have of getting a mortgage that you’re not just ok with, but pretty freaking pleased about.
Mortgage Qualification Demystified
Although every new borrower goes into a mortgage thinking that it’s a magic process full of unknown factors that appear randomly when they least expect them, the truth is that qualifying for a mortgage is fairly straightforward. It just seems like a gauntlet because you get so much new stuff thrown at you all at the same time, and you’re sort of seriously stressed worrying that you won’t be approved after jumping through so many hoops. Almost every borrower goes through this high pressure experience, unfortunately, but knowing what to expect can make it a little easier.
A mortgage qualification is a simple process, really. The property and the borrower are qualified separately, but for the purpose of this article, we’re only going to focus on you. You’re all that matters here. These are the primary items that your lender is going to look at when it comes to qualifying you:
– Credit history
– Job history
– Current base income
– Income potential
– Cash reserves
– Assets and investments
Let’s break each of these items down and discuss what lenders are looking for in an ideal candidate and how you can inch your way toward becoming that perfect borrower. Don’t worry, no one is a perfect borrower, but the better you are, the more likely you are to get the loan you want. The world of home mortgages can be your oyster.
This one is kind of a no-brainer. Everybody knows you need good credit to get a loan, so we won’t spend too much time lingering here. Pay your bills on time, don’t take out more debt than you can reasonably repay, try to keep your revolving credit under about 30 percent of the limit (yes, that little, for real) and don’t close any credit lines that you happen to pay off. You’ll need them to help decrease your debt to credit limit ratio.
Kind of another given. No one will loan you anything, even a lawnmower, if they don’t think you’re stable and they can find you if you don’t bring it back. Having a track record of being at the same company for a while, or in the same field, looks really good for you. This is not to say that you can’t change jobs, but try to limit it to the bare minimum in the three year period leading up to your mortgage application.
The more stable you look to your lender, the happier they’re going to be. There are exceptions, of course. If you’ve been in school for the thing you’re doing now or if you do a thing that is, by its very nature temporary, some lenders are willing to accept that you’re probably still pretty ok. They’re still going to verify that you really did all those jobs, though, so start keeping a list.
This is where the rubber meets the road. Can you actually afford to buy a house? Are you swimming in debt? Are you using debt to pay your debt? Your lender wants to know that you’re not so encumbered that one small bout of food poisoning will result in the entire house of cards falling down and your mortgage ending up in foreclosure.
Try to pay off anything you can, focusing on the biggest monthly payments first. Your future lender is mainly concerned with things that show up on your credit report, so that $100 you borrowed from your brother isn’t really on their radar unless you just can’t bear the weight of the secret and confess it. Even then, they’re not going to get too worried about it.
Current Base Income
People get kind of cranky about this particular item, so let’s just get it out in the open. When lenders look at your income, they’re looking at your base income. They’re not considering bonuses, even if they’re regular, and they don’t give two shakes about all that grueling overtime you’ve been putting in.
The reason for this is that it can’t be relied upon. They only want to use income they know will be there in a near-worst-case scenario. Obviously not having a job would be worse, but if your company needed to slash overtime and stop giving out bonuses, your bank wants to be sure you can still make the payment. Aside from demanding a raise from your boss, there’s not a ton you can do about this.
Mortgages are typically 15, 20 or 30 years in length. Because of this, banks want to know you’re going to be good for the long term. Makes sense. That’s why they poke into your job history and your income stuff so deeply. Your potential to continue to remain employed and to make as much, if not more, money as you do right now is a great big checkmark in your “good to go” column.
Do you have a giant vault of money that you swim around in like famed avian tycoon Scrooge McDuck? No? Well, that’s ok. If you did, it would be a lot of wasted effort to get a mortgage when you could just use those gold coins to pay for a house yourself… ahem.
Cash reserves are whatever your personal money vault currently holds. That’s going to include your savings account and whatever amount of money tends to stay put in your checking account. If you haven’t been saving, now’s as good a time as any to examine your spending and make some little changes that will add up to big cash when it comes time to apply for a mortgage.
Those cash reserves are great for so many things as a homeowner, even if you don’t end up needing them at the closing table.
Assets and Investments
The friendly neighborhood 401(k) is probably the most commonly overlooked investment that a large number of potential homeowners have available to them for this particular round of the mortgage qualification game. It’s easy to forget you’re stashing money away in one since it’s automatically deducted and, if your employer’s awesome, there’s some sort of matching that helps you save even faster.
Other investments would include things like stocks, bonds, futures, rental property, stakes in startups that are making money, that sort of thing. Whatever you have, disclose it and if the banker thinks it’ll hold water, they’ll submit it to underwriting to see how it fits into your lending program of choice’s particular rules. These are purely optional, but can help fulfill requirements like reserve funds, when needed.
When Your Best Isn’t Good Enough: Mitigating Factors
Sometimes, no matter what you do, your best isn’t good enough. Your credit’s just a little too unstable, you haven’t been on the job long enough, your bank account is consistently on “E.” When the loan officer comes back with a downturned head and a frown, don’t despair — not yet, anyway. This is when mitigating factors can come into play.
To explain mitigating factors, it’s important that you understand that most mortgages these days are automatically underwritten. Underwriting, for the uninitiated, is sort of the entire process of examining your materials and determining if you’re a good risk for the loan. Fleshy people still have to verify the information that was fed into the computer, but the computer gives the yes or the no, based on a risk-based algorithm.
Sometimes you break the algorithm and it kicks your file right up to a manual (human) underwriter. This person looks at your evidence and your argument for why you’d be a great mortgage holder and never, ever default, and they make the final call. They often do this based on the cards you’re holding in your particular hand. Those are the mitigating factors. There are a couple of examples below, but these are just the tip of the iceberg.
Example #1: Let’s say that you only want to borrow $300k. Your credit is pretty ok, not perfect, but not bad. But, you’ve switched career fields in the last three years and what you’re doing now is totally different from what you were doing, but the income is more or less the same. That’s sort of a huge scary red flag for the computer. As a mitigating factor, you have $100k between your savings and other liquidatable assets. You might very well be approved for the loan anyway because of your assets and cash reserves.
Example #2: You have a good job, a stable job, the pay is ok, but your student loan debt is such a bugaboo. Under the bank’s calculation method, the way your student loan will figure into your debt to income ratio throws your entire DTI into the red zone. You don’t even make the payment the bank figured because you have a modified payment plan, that’s the real steamer! But, you have good credit, you have that 401(k) at work you’ve been slowly contributing to and it’s up to around $50k.
Your good credit, your good job history, your stability and that 401(k) may be plenty of mitigating factors for the bank to go to a “stretch ratio,” effectively allowing you to borrow even though their own guidelines say you shouldn’t.
There are all kinds of ways to win with mitigating factors, but it’s always easier if you don’t have to invoke them. The more you have to mitigate, the more you have to document and the longer it takes to get to the closing table. Best to come with your best face forward the first time.