In my first job out of college, I worked at a bank. In addition to responsibility for the teller, new accounts, and customer service functions of our branch, I was responsible for reviewing new credit card, line of credit, auto, and mortgage loans applications. Here are some of the secrets of how bankers look at your loan application when you apply for a mortgage.
The first thing bankers look at when you apply for a loan is your credit score. While many people are mystified by how your credit score works, the company responsible for the FICO credit score, the Fair Isaac Corporation, has published the basic information about how your score is calculated. Here are the basics:
- Payment history
- Credit balances
- Percent of credit used
- Average age of credit lines
- Recent credit score inquiries
Depending on your bank, the minimum credit score to qualify for a home loan may vary. At the minimum, many banks require a score well above 600. To qualify for a good interest rate, banks generally require a score above 680. For the best interest rate, your score must be above 720. The highest possible score is 850.
Once we qualified potential borrowers with their credit score, we moved on to the hard part. We looked at each line on your credit report to decide whether we would approve the loan or not. Some banks use computerized algorithms to do this, but at my bank we vetted each borrower individually through a detailed review process.
When I reviewed credit reports for loan applicants, I looked at similar criteria to what raises and lowers your credit score. I removed “authorized accounts,” credit card accounts that are under someone else’s name. With the remaining, I looked at payment history and balances.
When looking at someone’s credit, past performance is the best indicator of future performance. Reviewing each account in detail for late and missed payments, irresponsible borrowing practices, and maxed out credit lines allowed us to vet out which borrowers would be most likely to pay back their loans as scheduled.
Loan to Value
Once we determined that you were a good credit risk, we would look at the property and requested loan amount. As a general rule, someone putting a 20% down payment would be in good shape to get a loan. More than 20% was great. Less than 20% took a very strong borrower with excellent credit and a high income.
Loan to value is the percent of the value of the home that will be financed by the bank. For example, if you are looking to buy a $300,000 home, we would generally be willing to finance up to 80% of the value. Your down payment would be at minimum 20%, or $60,000 for this home. If you only had $40,000 saved for a down payment, we would finance a home up to $200,000.
In the event you do buy a home with less than 20% down, banks require to your purchase additional insurance called private mortgage insurance, or PMI. PMI is an additional monthly cost on your loan to protect the bank in the event you are unable to pay your mortgage.
Debt to Income
The final check banks make when vetting your loan application is looking at your debt-to-income ratio. This was a check on your income, monthly expenses, and the additional expense of the home loan. We only made loans to people who really could pay them back, we were not into the predatory loan practices that got the big lenders like Countrywide in trouble.
To calculate your debt-to-income, add up all of your monthly payments from existing loans, such as credit cards, student loans, and car loans. Next, add your future mortgage payment plus property taxes and insurance. Divide that number by your monthly income.
A lower portion of your monthly income going to debt payments and fixed expenses makes you a better risk, and help you get approved for your loan.
It is all about the Total Package
As you can see, getting approved for a mortgage isn’t all about your credit score. There are lots of moving parts in your credit history, and many other factors that help you buy your next home. To make the process easier, always be sure to live within your means, pay your bills on time, and find a house you can really afford. Don’t focus on buying the biggest or most expensive house possible. Instead, find the right fit for your needs and your finances.
If all goes well, the property value will increase and, before you know it, you’ll be on to something bigger and better.