When a buyer begins the home-buying process, it’s helpful to have a pre-approval letter from a lender, this shows that the buyer will likely qualify for a mortgage loan of a certain amount. If the buyer finds a home he or she wants to purchase, the seller can take the offer seriously. Pre-housing market crash, getting a pre-approval letter was a cinch, but these days it’s much tougher.
First, a buyer needs to provide a lender with multiple financial documents such as pay stubs, W2s, bank and other account statements and tax returns; and personal information such as a Social Security number and previous addresses. Talk to the lender to get a specific list of required documents, as these vary from lender to lender.
Once a buyer hands over that financial and personal information, the lender begins evaluating them to see whether the buyer is a good candidate for a mortgage loan. If so, the lender determines how large of a loan and at what rates and terms to offer. Here are five things lenders are looking for when determining whether to pre-approve a buyer.
1. High Credit Score
One of the first things a lender does is run a buyer’s credit report, which shows the lender how likely it is that the buyer will repay the mortgage loan on time. Typically, lenders obtain a buyer’s FICO score from the credit report — this is a credit score issued by Fair Isaac Corporation — which is determined by how often consumer paid past bills on time (35 percent of a score is determined by this); the amounts owed on debts such as credit cards, loans and mortgages (30 percent); the length of time a consumer has had credit (15 percent); new applications for credit (10 percent); and the types of credit a consumer has (10 percent). Credit scores range from 300, which is poor, to 850, which is excellent. Most lenders want consumers to have a score of 660 or higher, though this varies from lender to lender.
2. Low Debt-to-Income Ratio
A borrower’s debt-to-income ratio is the amount of monthly debt compared to gross monthly income. The debt-to-income ratio shows lenders how the cost of a new mortgage payment would impact a borrower’s ability to pay off the loan. So, a person who pays $2,000 per month for debts and brings in $4,000 per month in gross income would have a debt-to-income ratio of 50 percent ($2,000/$4,000). Lenders like to see a debt-to-income ratio of less than 40 percent this includes the principal, interest, real estate taxes and insurance of the new projected mortgage payment.
3. Solid Employment History
Most lenders want to see buyers who have been in the same job, or at least the same field, for a minimum of two years. Job stability indicates to the lender that the borrower should be able to pay the loan for years to come. Lenders verify the employment history and likely call a borrower’s employer to confirm current employment details.
4. Significant Assets
Even if a borrower’s debt-to-income ratio or credit score aren’t at the top of the charts, he or she isn’t doomed from getting pre-approved for a mortgage loan. Buyers who have large amounts of money for a down payment, significant assets or high levels of savings are still able to get pre-approved as this indicates to lenders that the buyers can repay the loans.
5. Money to Close
Lenders also review borrowers funds to make sure they have enough money to pay the required down payment and the closing costs. Closing costs average between 2 and 5 percent of the purchase price of the home, which means a person buying a home for $150,000 might pay between $3,000 and $7, 500 in closing costs. The lender may look at the buyer’s savings, brokerage and bank accounts to ensure there’s enough money available to pay those costs.