For many people, the most daunting part of the home-buying process can be getting a mortgage. But it doesn’t have to be a difficult endeavor, even if you have never before gotten a mortgage. Here, The Motley Fool offers some simple moves to take before you apply to help ease the process along.
1. Begin early
When a lender looks at your creditworthiness for a mortgage loan, time matters. If you can start paying down debt well before you apply (and pay off items such as car loans) that can help. Lenders approve loans partially based on your debt-to-income ratio, meaning how much debt you have compared with how much income you have coming in. In general, a lender doesn’t want to see this ratio go over 43 percent, according to the U.S. Consumer Financial Protection Bureau, but lower is better. Paying off a credit card or eliminating another term loan will improve your ratio. That could increase how much you can borrow and also improve your chances of being approved.
2. Know your credit
Your credit score also will affect whether you get approved. Scores—which go from 300 to 850—are derived from how you use credit and how you pay your bills. Each of the three major credit bureaus (Equifax, Experian and TransUnion) use slightly different criteria, so your numbers with each won’t be the same. But this is the rough breakdown of how your score is determined:
• Payment history (35 percent)
• Amounts owed (30 percent)
• Length of credit history (15 percent)
• New credit (10 percent)
• Credit mix (10 percent)
3. Fix your credit
Only some portions of your credit can be fixed in the short term. The big one you can have an impact on is amounts owed. Pay off your balances in full, and your score will go up. Also avoid opening new accounts or doing anything that triggers a credit check during the mortgage application process. A new account can harm you, because lenders don’t want to see a customer have too much available credit, as that lets them run up debt—which could interfere with the ability to pay their mortgage.
4. Know how much you can borrow
Mortgage lenders typically use the 28/36 rule. That means your total mortgage payment—including taxes and insurance—shouldn’t exceed 28 percent of your pre-tax income, while your total debt shouldn’t exceed 36 percent. Although it’s not a hard and fast number, it’s the basic guideline most lenders use.
5. Have your paperwork in order
Most mortgage lenders will want to see the two most recent pay stubs, two years of taxes and at least 90 days of bank account statements for anyone on the mortgage. In many cases, they also will request documentation of any investments and retirement accounts. Put this package together before you start applying, and update it as you go. Also remember that your lender may ask for bank statements and pay stubs after an approval has been granted but before the loan has closed.
6. Be ready to defend your finances
Your lender almost certainly will ask about any income that shows in your bank account that your pay stubs don’t explain. For example, if a family member gave you a large gift to help with a down payment, you may have to fill out paperwork and get your relative to sign and document that it’s not a loan. You also will have to explain everything from a work bonus to a scratch-card win if the amount looks suspicious. Basically, your lender wants to make sure the financial picture you present reflects reality.