What does the
lender consider when you apply for a Mortgage
How does the
lender determine your ability to pay the mortgage?
Lenders need to "document" your
income through pay stubs and W-2 forms. If you have a job with
substantial bonus or commission income, they may need to see your
income tax statements or obtain written and/or verbal verification
of this income from your employer. If you receive or pay out child
support or alimony, they'll need to see your divorce decree. When
receiving child support or alimony, that information is optional to
disclose. Self-employed applicants will have to supply additional
documentation to demonstrate the profitability of the business you
These documents will assure the
lender that you have the ability to make your PITI monthly payments
(consisting of principal, interest, taxes and insurance) as well as
meet your other financial obligations.
They'll also look at your income
source(s) and employment history. A lender needs to be reasonably
certain that your employment will continue, and periods of
unemployment or frequent job changes will require logical
How does the
lender determine your willingness to pay the mortgage?
Every lender will need to
"measure" your willingness to pay your mortgage by looking at how
you've paid your rent, your car loan and other debts in the past.
If these bills were paid regularly
and on time, they will have confidence that you'll pay your mortgage
on time too. Your payment history is recorded by a credit bureau on
a credit report, which your lender will order for you when you make
your mortgage application. Your credit report does not have to be
perfect, but it does have to present the picture of a responsible
individual who takes his or her obligations seriously. If your
credit report shows some delinquencies, your lender may ask you to
explain these in writing.
Some people have little or none of
the type of credit that shows up on a credit report. When an
individual has no credit, there's no way for a lender to tell if
you'll be a reliable mortgagor. In many cases, however, they can
help you build a credit history by documenting your payments to the
telephone, gas, and electric company, as well as to your landlord.
How does the
lender determine your ability to close the transaction and maintain
your future obligations?
You may need a certain amount of
cash to purchase a home. Depending upon the loan product, your cash
can come from several sources: your own savings, a gift from a
relative, a sales concession from the seller, a grant from a
community agency or employer, or from the lender. The source of this
money must be carefully documented through bank statements
indicating that the funds do, in fact, exist, and through gift
The exact amount of the funds you
need will be determined by your loan amount and program, the
location of the property, regional fees associated with the
transaction, and your own miscellaneous costs such as payment to
your own attorney.
In most loan programs, at least a
portion of the downpayment must come from your own funds. This
demonstrates to the lender that your home is an investment that is
important to you. For example, if the loan program you select
requires a 5% (some may be a low as 0%
- 3%) downpayment, and the purchase price on your home is
$100,000, your downpayment will be $5,000. However, you may only
have to provide a 3% downpayment from your own funds, totaling
$3,000. The remaining 2%, or $2,000, can be a gift or grant. FHA
loans are an exception since the entire downpayment may be a gift,
and VA loans require no downpayment.
There are a number of costs
associated with closing that range between 2% and 6% of the mortgage
amount, depending on the costs and fees typical to your geographic
region. Many first-time home buyer programs allow all or some of
these closing costs to be paid by someone else. To eliminate
surprises and help you prepare, you will receive a detailed "Good
Faith Estimate" of your closing costs shortly after you apply for
your mortgage loan.
Some loan programs require that,
at the time of closing, you have additional money in your savings
account equivalent to one or two monthly payments (principal,
interest, taxes and insurance). If PITI reserves are required at
closing, they frequently must come from your own funds. Your loan
officer will provide exact details for you.
How does the lender determine the
fair value of the home you are purchasing?
Every lender must protect your
investment as well as its own, by hiring a trained appraiser to
inspect the property you want to buy and determining its "market
value." The appraiser determines market value by comparing your
property to similar nearby properties which have been sold recently.
These properties are called "comparables" or "comps." If homes like
the one you want to buy have sold for about the same price the
seller wants you to pay, then the appraisal should present no
Other Compensating Factors
How closely does your financial
condition (income, assets, credit) need to match the loan criteria?
Approval guidelines for each loan
product are just that: guidelines. The guidelines for every loan
product include what are referred to as "compensating factors." This
means that although your financial condition may be "weak" in one
area, other strengths can compensate for that weakness.
For example, in determining your
ability to make your monthly payments, the lender uses "qualifying
ratios." These ratios differ from loan product to loan product. If
your qualifying ratio is higher than the acceptable ratio for that
loan program, the lender will look for "compensating factors."
Compensating factors may be one or
more of the following:
Is the full
downpayment coming from your own savings?
Will you have a
relatively low loan-to-value?
rental payments been roughly equal to your projected PITI payment,
and have they been made on time?
Have you been
able to consistently save money over the years?
Do you have
savings above and beyond what will be required for the downpayment
Are you in an
employment position that has upward mobility?
If one or more of those factors
can be answered positively, they may compensate for a high