Answers to Questions about Qualifying for a Loan
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What is the lowest amount I have to use for a down payment on my home purchase?

A 20% down payment was the standard years ago, but most lenders will allow the buyer to put as little as 5% down. On a $100,000 loan, the homebuyer would be expected to come up with at least $5,000. When you put less than 20% down, you will be required to purchase mortgage insurance (about $30-$50 a month ). Don't forget that you will also be expected to pay for additional closing costs, so allocate for these costs when saving up to buy your home.

Should I put down as much as possible when buying my home?

Any down payment above and beyond your lender's minimum requirements will depend on your financial situation. At the minimum you should leave enough funds available to cover related loan costs and two months worth of mortgage payments. Any remaining funds should be used to best fit your total financial picture. Would you better off investing the money, buying furniture, and reaping the benefits of a larger mortgage interest deduction? The answer will depend on your financial goals.

I've heard that most lenders will allow a borrower to have a 28% debt-to-income ratio in order to qualify for a home loan. What does this mean?

In order to minimize the chances of a borrower 'getting in over their head' financially, most of the lending industry has agreed that a borrowers monthly housing expense should not be greater than 28% of the borrower's gross monthly income (income before taxes). This 28%, often referred to as the 'housing to income ratio' or 'front-end ratio', includes the monthly loan payment, real estate taxes/assessments, homeowners insurance, mortgage insurance and association fees (for condo or townhome owners). The allowable percentage can vary by lender.

What is the 36% debt to income ratio?

A lender may tell you that its income qualifying ratios are 28/36. The 28 means that 28% of your gross monthly income can go toward housing expenses. The 36 means that 36% of your gross monthly income can go toward all of your monthly debt (including housing debt). This amount is often referred to as the 'total debt to income ratio' or the 'back-end ratio'. This amount can include monthly payments on credit cards, installment loans (auto, student loan, etc.), child support/alimony payments or other monthly payments required by a court ordered judgement. The allowable percentage can vary by lender and loan circumstances.

What is the difference between getting pre-qualified and getting pre-approved for a loan?

 A pre-qualification is an estimate by a mortgage lender of how much you can afford to borrow. It is based upon the information you provide, and final loan approval is subject to further details such as a credit report, property appraisal, and income verification. A pre-approval is a firmer commitment on behalf of the mortgage company. Based on some credit investigation of the borrower, the lender will guarantee that a loan can be made for a certain amount (subject to property approval by the lender).

Should I get 'pre-qualified' or 'pre-approved' before I begin house hunting?

At the very least you should get pre-qualified by a lender. By knowing the amount you can borrow, you can save yourself the time and heartache of looking at homes that you cannot afford. By getting pre-approved, you not only go into the house hunt knowing you will get a loan, but you will also have added bargaining power when it comes to negotiating a purchase price for a home. A seller may be more accommodating to a purchaser that is guaranteed financing.

How important is job stability when applying for a mortgage loan?

Lenders like to see job stability in a loan applicant. A stable job means a steady income to make the loan payments on time. On average lenders prefer the applicant to have two consecutive years in the same line of work. Ideally this would be two years at the same job. Lenders understand that people change jobs, so job changes within the past two years may be acceptable as long as income hasnt declined too dramatically and the applicant provides a letter explaining why the job change took place. Many lenders will also count college as work experience if the graduate is working in his/her field of study.

What if I am self-employed or I dont have a two year job history?

Self-employed borrowers are evaluated on health of their business as well as their personal credit, so most lenders require about a two year business history. If your employment history falls short of two years, you may still be able to get a loan if the lender feels you have enough compensating factors. Compensating factors can be a large down payment (20% or more), substantial spouse income, large asset reserves, excellent credit history, etc. There are no hard and fast rules regarding compensating factors. Their ability to offset a short employment history depends on each individual situation and lender guidelines.

I need a mortgage loan to buy a home but I do not want to disclose my income to a lender. What are my options?

Many people, particularly those that are self-employed, do not want to disclose the financial details of their business/income. Many lenders will offer low-doc or no-doc loans to individuals who require such privacy. A low-doc or low documentation loan requires the potential borrower to submit only a portion of the borrower documentation normally required by the lender. With a no-doc or no-documentation loan, the lender does little, if any borrower income & asset verification and is essentially taking the borrowers word that they will repay the loan.

These reduced documentation loans seem to be an easy way to get a mortgage loan. Why doesnt everybody use them?

Since a lender is doing less verification of your ability to make the loan payments, there is a greater risk that you could default on the loan and create a potential loss for the lender. To offset this added risk, the lender may charge a higher interest rate that would be charged on a fully documented loan. The lender will also likely require that the borrower put a substantial amount of down payment on the purchase (at least 20%). The extra down payment reduces the lenders financial exposure in the transaction and demonstrates some financial capability of the borrower.

How do I fix blemishes that appear on my credit file?

If there are errors on your credit file, contact the reporting agency and inform them of the mistake. The agency may have to contact individual creditors to verify the data, so this could take some time. If the creditor insists that the information is correct, you may have to contact the creditor directly to get the discrepancy resolved. If you have failed to meet your debt obligations in the past, there is no way to erase these blemishes from your credit file. If your credit problems were caused by extraordinary circumstances (job loss, illness, catastrophe), write a brief explanation explaining the situation and ask to have it included in your credit file.

I have heard that lenders use a FICO score to determine a borrowers eligibility for financing. What exactly is a FICO score?

When you take out a loan or get a credit card, that particular creditor provides your account information and payment history to a credit bureau (like Experian, Trans Union, or Equifax) on a regular basis. This information is complied into a credit report, which can be purchased by a lender. The credit bureau also puts this information into a mathematical equation that generates a credit score, which provides a statistical, non-biased way for a lender to determine your ability to handle certain credit obligations. Many credit bureaus use the equation developed by Fair, Isaac & Company, which generates a FICO score.

What is considered a good credit score?

The quality of a credit score depends on the statistical method used by the credit bureau. With some methods it is better to have a lower score. If the bureau is using a Fair, Isaac scoring system it is preferable to have a higher FICO score. However, a credit score may not mean the same thing for every lender. Lenders can have different requirements for what is considered to be an acceptable score. If you want to maximize your chances of getting approved for a loan, the best thing that you can do is to ensure you handle all of your credit obligations responsibly. By doing this you will better you credit score regardless of the method used.

I have had credit problems in the past. How does this impact my chances of getting a home loan?

Obtaining a home loan is possible even with extremely poor credit. If you have had credit problems in the past, a lender will consider you to be a risky borrower to lend to. To compensate for this added risk, the lender will charge you a higher interest rate and usually expect you to pay a higher down payment on your home purchase (typically 20-50% down). The worse your credit is, the more you can expect to pay for an interest rate and a down payment. Not all lenders choose to lend to risky borrowers, so you may have to contact several before finding one that will.

I have only been late a couple of times on my credit card bills. Does this mean I will have to pay an extremely high interest rate?

Not necessarily. If you have been late less than three times in the past year, and the payments were no more than 30 days late, you probably have a pretty good chance at getting a home loan at a competitive interest rate. Lenders guidelines will vary, but most lenders will excuse a couple of minor late-pays as long as the borrower can provide a reasonable excuse explaining them (i.e. job transition, illness). If the late-pays were 60+ days late and cannot be explained, you may have to settle for a higher interest rate.

I have had some severe credit problems over the past couple of years. Is there any chance that I can get a home loan?

There are lenders that will give you a mortgage loan, but it will not be cheap. Since you will be considered a risky borrower, the lender will require a substantially large down payment (25-50% down) on your part and will charge you a much higher than market interest rate. Depending on the severity of your credit problems, you could expect to pay an interest rate 5-7% higher than the average rate on a standard loan for good credit borrowers. A lender may be able to offer an adjustable rate loan with a low starting rate, but rates on such loans can be subject to sharp upward movements.

Will a lender lower its interest rate on my loan if I clean up my credit after a couple of years?

If you make all of your mortgage payments on time and re-establish other forms of credit (car loan, credit card), you can certainly approach your lender and ask that it refinance your loan at a more attractive interest rate. If you have kept a spotless credit record since you moved in, your lender will most likely lower your interest rate to prevent you from refinancing with another lender. You should also however talk to other lenders to see what type of interest rate you can receive. Once your credit is cleaned-up, you will be in a position to comparison shop for the best rate.