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The simple guide to lending criteria for home loans
Find out the approval policies banks have in place to determine if you qualify.
Banks and lenders have a set of criteria they use to assess mortgage applications. Planning ahead can help you pick the right lender and get approved for a mortgage with a competitive interest rate.
What kind of borrower are you?
The first detail banks will look at is exactly what sort of borrower you are. This includes:
Your residency
A lender will want to know whether you’re a permanent resident of the US.
While non-residents can still get mortgages with some lenders, it will be more difficult to get approved. You may need a larger down payment, and some banks will have lower limits on how much you can borrow. You may also face stricter lending criteria, which means that a potential lender will need a lot of information to be confident that you’ll pay back the loan.
Your situation
A lender will want to know if you’re borrowing as an individual or a collective. In other words, you may be sourcing a home loan as a company or as the trustee of a trust. Lenders will allow companies and trustees to borrow, but will require specific documentation and are likely to have different lending criteria in place.
What’s your work situation?
Lenders will need to examine your work situation to determine that you have a steady source of income. The way your income is assessed will depend 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.
- Type of employment. Lenders will want to know if you’re a permanent, seasonal or contract employee. If you’re a seasonal or contract employee, you’ll need to be able to prove your ability to keep repaying 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 will require documents showing a much longer history of your income than you’d need to show with a traditional job. This can include bank statements, prior tax returns and any financial documents from your business. In some cases, you may be eligible for a lower mortgage amount than a full-time employee with a similar income.
What is your financial position?
The next thing lenders will want is a detailed view of your financial history, habits and overall health. In order to get that, they’ll look at a few different factors.
Your assets
A lender will also take into account any assets you have. This includes money in savings accounts, investments, vehicles, other properties and any other stored money.
Your liabilities
Your liabilities include any debts you might have. This could be credit cards, personal loans, car loans or student loans. Your debt-to-income ratio is one of the biggest determining factors in qualifying for a mortgage.
Your liabilities can also include regular expenses, like child support, alimony or back taxes that you’re responsible for paying.
Your income
Aside from your work income, lenders will want information about any other income streams you have. This can include Social Security income, rental income, investment income, alimony and any other regular source of income.
On average, lenders tend to assume that you can spend about 28% of your income, minus any debts or liabilities that you’re paying, on a mortgage. If you try to take out a mortgage for more than 28% of your income, lenders will be concerned that you won’t be able to afford other expenses, like utilities, groceries and everyday expenses, and could deny your application.
Your credit score
Lenders will also want to look at your debt repayment history. They do this by checking your credit history and credit score.
If you have 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.
Your down payment
How much you need for a down payment will depend on your credit history, income and the type of loan you’re getting. It can range from $0 for a VA loan to 10% or more down for a conventional mortgage.
If you have less than a 20% down payment, you may have to pay for private mortgage insurance (PMI), an insurance policy that covers your lender in the event you default. This expense can add tens of thousands of dollars to the cost of your home loan.
Parts of your deposit can come from sources like gifts, financial windfalls or inheritances. But most lenders will want to see the majority of your down payment coming from sourced and seasoned savings, which means the money you earned that’s been in the bank for at least 60 days.
How much are you 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.
What sort of property are you buying?
Next, lenders will want to know the kind of property you’re buying. The property will be used as collateral for the mortgage, meaning that if you default on the mortgage, your lender will sell the property to recoup the money they’ve lent you. Because of this, banks scrutinize the type of property you’re considering.
- Its location. Some lenders have restrictions on which zip codes they will lend in. Some rural areas and areas with a bad housing market might not be competitive.
- Its structure. Your lender will want to know if you’re buying a house or a condo. Lenders often have more stringent criteria when it comes to lending for condos. They’ll also want to know that the property has running water and electricity, is zoned for residential use and that it can be accessed without driving through someone else’s property.
- Its size. This can include both the size of the home and the size of the land it’s on. Small condos that will be difficult to resell and large plots of land that will likely serve as a business may be harder to get funding for.
- Its value. The lender will have an appraisal done on the property. If you’re buying a home for significantly more than its worth, you’ll have trouble finding a lender.
- Its use. If you’re buying a rural property, it can’t be used for farming if you’re getting a mortgage for a primary residence.
Why are you buying it?
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. While investors face tighter lending criteria and are often saddled with higher interest rates, they are sometimes able to borrow larger amounts because lenders assume rental income will help them pay back their home loan.
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Bottom line
A lender will consider 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 shopping.
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