Many borrowers feed into the myth that your credit score is the only deciding factor when getting approved for a new mortgage. In reality, lenders look at a variety of factors before approving a new mortgage loan.
While your credit score does certainly play a role in the approval process, lenders also look at things like your payment history and credit utilization, employment history, available assets, and so much more.
When you apply for a new mortgage, expect your financial profile to be an open book. Lenders will want to complete a comprehensive review to feel comfortable lending you money for your new purchase or refinance.
In fact, most lenders follow five fundamental key points when reviewing your loan application: capacity, character, capital, collateral, and common sense (also referred to as ‘condition’).
Before you apply for your next mortgage, here are some things to consider that lenders look at when approving a new home loan.
Here are some things to consider that lenders look at when approving a new home loan:
Credit Factors Other Than Score
Credit scores play an important role when it comes to analyzing a borrower’s creditworthiness, but it’s not the only factor that lenders consider when approving a loan.
One of the biggest factors that help you build an excellent credit score and that is reviewed by lenders is your payment history. Lenders review your credit report to make sure you pay all your accounts on time.
Lenders find delinquent accounts or accounts that are 30 days or more past unfavorable. Unpaid collections or charge-offs can also negatively impact your application.
If you have a history of homeownership with prior or current experience paying back mortgage loans, it’s equally important that you do not have any delinquencies past 60 days or unless you can provide a sufficient explanation why the payments were missed.
Similarly, if you have experienced a major derogatory event such as a bankruptcy or foreclosure, you may have to wait an appropriate amount of time from the date the event was either dismissed or discharged to be eligible for a new mortgage.
Credit Mix and Authorized Users
In fact, the types of credit accounts you hold is one factor that lenders weigh when conducting their analysis. In general, you want to have multiple types of tradelines which could include but are not limited to installment loans, home loans, and revolving debt.
But don’t try to hoodwink a lender by signing up as an authorized user on other people’s accounts just to broaden the types of tradelines you hold. Lenders tend to scrutinize accounts where you are an authorized user versus a primary account holder much more heavily.
Although creditors want to see that you have a sufficient credit history, that doesn’t mean you should always use the amount of credit available to you.
The best way to keep your credit score high and maximize your chances at getting approved for a new mortgage is to not open any new tradelines just before or during the application process.
New inquiries not only negatively impact your credit score, but they will trigger your lender to ask for additional explanations about any new debt. If you do open a new account and your numbers are tight, it could make or break your application.
Also try to pay down accounts with higher balances and stick to only using 30% or less of the credit available to you.
FICO Credit Score
Most borrowers are unaware that there are a variety of credit scoring models that creditors use to help gauge borrower’s creditworthiness.
When it comes to mortgages, almost all lenders rely on the FICO credit score which is a three-digit number produced from the three major credit repositories. This number can be slightly different depending on the credit bureau. Lenders typically utilize your mid-score to determine your eligibility.
Lenders like to see a FICO credit score of 620 or more, however some government-sponsored mortgage programs may allow borrowers to qualify with a lower score. The average FICO credit score among U.S. households is currently 7111.
Debt-to-Income (DTI) Ratio
In combination with your credit history, lenders rely heavily on your debt-to-income (DTI) ratio when making a credit decision for a new mortgage loan.
Think of your debt-to-income ratio as the total amount of money you pay monthly across all accounts in relation to how much money you gross or earn on a monthly basis. You essentially want to have more money coming in than going out (so less debt and more income).
Most providers look for you to have a DTI at or below 43%. However, some lenders may have mortgage solutions that offer additional flexibility depending on the mortgage program you choose as well as a variety of other compensating factors. In some cases, you can still qualify for a mortgage with a DTI at or below 50%.
If you are applying for a new mortgage, it’s important that your income, be enough to qualify. But what is equally important is the stability and likelihood your employment will continue from which that income is generated.
Lenders try to measure a reasonable employment history when approving a new mortgage by analyzing your employment patterns over the last year or two. Major gaps in employment or industry changes might be questioned and need further documentation.
Liquid Assets and Reserves
A mortgage can be a great financial tool, but it doesn’t always cover the entire amount of money necessary to complete any given purchase or refinance. Lenders are required to analyze and source the assets you will be using to cover your down payment or closing costs.
Riskier assets such as stocks, bonds, and other securities might require an additional layer of verification including proof that the underlying assets themselves have been liquidated and that you have received the funds from the sale prior to closing.
Additionally, depending on the type of mortgage you are applying for, your lender may also request to see additional assets over any funds needed for closing as reserves. Reserves are often verified to validate you have sufficient assets to cover your loan payments should you experience a potential hardship including but not limited to a job loss or injury.
It’s important to understand that the underlying collateral for a new mortgage loan is real estate. Thus, your lender will want to ensure that the real estate being used to secure the loan is worth enough to cover the balance should you be unwilling or cannot repay the debt.
Another key ratio that lenders look at is the loan-to-value (LTV) which basically takes what you will owe on the home (your mortgage balance) and compares it to the property’s market value. One way lenders determine a property’s market value is by ordering an appraisal report.
Requested Credit Terms
While income, assets, and credit are key factors that lenders look at to determine your eligibility for a new mortgage loan, they also look at a variety of miscellaneous criteria based on the credit terms you request.
The loan term your request as part of your mortgage application can have a tangible impact on your ability to qualify for new credit. Most mortgage loan terms can extend up to 30 years.
Typically, the longer your loan’s term, the lower your monthly payment. If you apply for a shorter term but might not qualify, your lender may suggest extending the loan term to help get you approved.
Number of Borrowers
While the minimum number of borrowers for a mortgage loan is one, you may decide you want to apply with another person or people. Lenders like seeing additional borrowers on a mortgage application because they find it reduces risk as more people are liable for the debt.
In contrast, if you do decide to apply with another person, keep in mind their credit, income, and assets will also be considered as part of the review process.
In general, mortgage providers prefer lending against property that will be used as a borrower’s primary residence. This is because distressed borrowers are more likely to try and make their payments on a property, they reside in.
While mortgages can be taken out against second homes and investment properties, keep in mind that the pricing and credit requirements might not be as favorable if the property was your primary dwelling.
1 Lembo Stolba, S. (2021, February 12). What is the Average Credit Score in the U.S. Retrieved June 16, 2021, from https://www.experian.com/blogs/ask-experian/what-is-the-average-credit-score-in-the-u-s/