Lending criteria for home loans

When it comes time to take that next step in your home-buying journey, you’ll want to have a feel for the criteria that lenders use to assess mortgage applications. Planning ahead can help you pick the right lender and get approved with a competitive interest rate.

To determine your eligibility and what rate you might qualify for, lenders look at your living and employment situation, your financials, your credit history — among other factors.

Your borrower profile

Before you go any further in the process, lenders will first need a general feel for who you are and your current situation in general. They’ll assess:

Your residency

A lender will want to know if you’re a permanent resident of the US. While nonresidents can still get mortgages with some lenders, it will be more difficult to get approved.

Your situation

Lender want to know if you’re borrowing as an individual or jointly. If, for example, you’re taking out a home loan as a company or as the trustee, lenders require specific documentation and are likely to set different lending criteria.

Your employment situation

Your loan officer examines your work situation to determine you have a steady source of income. The way your income is assessed depends on your type of employment.

Full-time employees

If you’re a full-time employee — meaning you receive a regular paycheck with tax withheld — you should have a relatively easy time proving your income. However, there are a few things lenders will scrutinize:

• Length of employment. Lenders may require that you’ve been employed in the same job for a certain length of time. This is typically two years, but varies from lender to lender.
• Type of employment. Lenders want to know if you’re a permanent, seasonal or contract employee. If you’re a seasonal or contract employee, you’ll need to prove your ability to repay the loan when the season or contract ends.

Part-time employees

If you work part-time, the process for proving your income will be just like a full-time employee. But you’ll need to be able to prove that you can make enough to repay the loan without working full-time.

Self-employed borrowers

If you’re self-employed, you won’t have regular pay stubs to show a lender. Most lenders require you to show bank statements, prior tax returns and any financial documents from your business.

Your financial position

The next thing lenders will want is a detailed view of your financial history, habits and overall health. To get that, they’ll look at a few different factors:

Assets

This includes money in savings accounts, investments, other properties and any other saved money. You’ll typically need to provide bank statements for the last two months.

Liabilities

Your liabilities include any debts including credit cards, personal loans, car loans or student loans. Your debt-to-income (DTI) ratio is one of the biggest determining factors in qualifying for a mortgage. Lenders typically look for a front-end DTI ratio of 28% or lower and a back-end DTI ratio of 36% or lower — though guidelines vary from lender to lender

What are front-end and back-end DTI ratios?

Lenders typically take both ratios into consideration, though your back-end ratio is likely to carry more weight in the approval process:

• Front-end DTI ratio. This includes all expenses directly related to your home, such as property taxes, insurance and the payments you’ll make on the home you’re trying to buy. Those expenses are tallied up by the lender, then divided by your gross monthly income.
• Back-end DTI ratio. The back-end ratio includes any debts that are likely to show up on your credit report. This can include revolving debts like car loans, credit cards and student or personal loans.

Income and proof of employment

Aside from your work income, lenders want information about any other income streams you have. This can include income from Social Security, rentals, investments, alimony and any other regular source of money. To verify your income and employment, lenders may request documents such as:

• W-2 forms, typically for the last two years
• Tax returns, typically for the last two years — more likely to be requested if you’re self-employed
• Pay stubs, typically for the last two months

Credit score

Lenders look at your debt repayment history to make sure you consistently pay debts on time. They’ll also assess things like your credit utilization and whether or not you’ve had any bankruptcies. Typically lenders like to see a credit score of at least 620, but the score you need depends on the type of mortgage you’re applying for.

Down payment

How much you need for a down payment depends on your credit history, income and the type of loan you’re getting. If you have less than a 20% down payment, you’ll have to pay private mortgage insurance (PMI) — an insurance policy that covers your lender in the event you default.

The amount you’re borrowing

The type of home loan and the size of the loan amount also affect your chances of being approved.

• The amount you wish to borrow must not exceed the lender’s maximum loan-to-value ratio.
• Your proposed borrowing amount must fit between the minimum and maximum loan limits set by the lender
• You must use the financing from the loan for its intended purpose. For example, you can’t get a mortgage for a primary residence if you plan to use the property as an investment and won’t be living there.

The property you’re buying

Next, lenders will want to know your occupancy status. In other words, they’ll assess whether the house will be your primary residence, secondary residence or an investment property. Banks assess the type of property you’re considering based on:

• Location. Some lenders have restrictions on which zip codes they will lend in. Make sure your lender of choice can provide assistance in your area.
• Structure. Your lender will want to know if you’re buying a house, condo or other type of structure.
• Size. This can include both the size of the home and the size of the land it’s on.
• Value. The lender has your property appraised at your expense. If you’re trying to buy a home for significantly more than it’s worth, you’ll have trouble finding a lender.
• Use. If you’re buying a rural property, for instance, it can’t be used for farming if your mortgage is for a primary residence.
• Purpose. If the house is a second residence, for instance, your credit score and down payment requirements are likely to be higher than they would for a primary residence. Check with your lender and understand the differences.

Reason for purchase

Lastly, a lender will want to know why you’re purchasing the property. The reason you’re buying your property will dictate the type of loan you’re eligible for, and often the amount you can borrow.

• To live in. If you’re buying as an owner-occupier, you’re likely to face fewer restrictions and get offered a home loan with a lower interest rate.
• As an investment. Investors may face tighter lending criteria and are often saddled with higher interest rates.

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Bottom line

A lender considers your full financial status and history when determining how much you’re eligible to borrow for a home. To get the best deal on a mortgage for your dream house, compare home loan lenders and get preapproved before you start house hunting.

Frequently asked questions

• Can I get a mortgage if I'm retired?

  Yes. As long as you can prove your ability to repay the loan, mortgage lenders can’t discriminate based on age. Find out more about getting a mortgage after age 60.

• Will my spouse's credit affect our loan application?

  If you’re applying for the mortgage together, yes. But if only one name is on the application and the home’s title, then only that person’s credit will be evaluated.

• Can I get a mortgage with bad credit?

  If you’ve had some rough patches in your credit history, there are still lenders who may be able to help. Some lenders specialize in mortgages for borrowers with bad credit. But keep in mind that you’ll likely have a higher interest rate, which can make your mortgage considerably more expensive in the long run. If you have bad credit, you may be better off waiting to buy a house until you can get your score up.

• What's the difference between mortgage prequalification and preapproval?

  A prequalification is an informal estimate of how much home you might be able to afford based on what you tell the lender in terms of your income, assets, debts and credit score.

  A preapproval is a more concrete estimate of what you’ll be approved for. To get one, supply the lender with actual financial documents.