Reader question: “How do I get approved for a home loan in 2013? I have heard there are some new rules going into effect next year. I’m just wondering if it will affect the approval process on the front end. Any insight would be much appreciated.”
You’ve heard right. There have been some new mortgage rules announced recently. Some will take effect in 2013, while others have been pushed into 2014. We will talk more about them as we continue through the lesson.
Here’s a general blueprint on how to get approved for a home loan in 2013:
How to Get Approved for a Home Loan
When you apply for a mortgage loan, the lender will examine all aspects of your financial situation. More than anything, they want to ensure you have the ability to repay your loan. In fact, the government now requires them to do this (as if common sense were not enough). This is one of the new rules you’ve heard about. It’s called the Ability-to-Repay rule, and it requires lenders to verify and document your financial ability to repay the debt.
So that’s the first thing you’ll need to get approved for a home loan in 2013. You must fully document your ability to repay the loan. You can expect the lender to look at your bank statements, tax returns, W-2 documents, and other items that relate to your earnings and assets.
Your lender will also want to know how you have borrowed and repaid money in the past. Have you been a responsible borrower? Or do you have a history of missing payments? This is where your credit reports and credit scores come into the picture. The lender will check your credit score soon after you submit your loan application. If your score is too low by their standards, they might not approve you for a home loan.
It begs the question: What credit score is needed to qualify for a mortgage loan? Most lenders today require a credit score of 620 or higher for conventional loans, and a bit lower for government-backed / FHA loans. But that number is not set in stone.
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Good credit goes a long way. Consider it ‘Chapter 1’ in how to get approved for a home loan. But it’s certainly not the only requirement. Lenders also want to see that you have a manageable level of debt. Specifically, they’ll want to know your debt-to-income ratio, or DTI. This is a comparison between the amount of money you earn each month, and the amount you spend to cover your debts. For instance, a person who spends one-third of his income on the debts he owes has a debt-to-income ratio of about 33%.
You actually have two different DTI ratios, when it comes to home loans:
- Your front-end debt ratio looks at the amount of income going toward housing costs, in particular (i.e., the mortgage payment and all related taxes and insurance). Most lenders prefer this ratio to be below 29%. But here again, that number is not set in stone.
- Your back-end debt ratio looks at all of your recurring debts, including your housing costs. This ratio brings car loans, credit cards, personal loans and other lines of credit into the mix. Most lenders prefer this number to be below 41%.
If your ratios are well above these rules of thumb, you could have trouble getting approved for a home loan in 2013. DTI ratios are a big deal these days. They’ve even been written into the qualified mortgage (QM) rules that are scheduled to take effect in 2014.
The government seems to be drawing the line at 43%, on the back end. That number appears within the QM documentation, and also within a new rule for FHA loans. This seems to be emerging as the new standard: In most cases, borrowers will need to have a back-end DTI ratio no higher than 43%. Keep that number in the back of your mind.
So, your credit score is part of how you would get approved for a home loan. Your debt ratios are another big part of the approval process. Lastly, we need to talk about down payment.
Unless you’re using a VA or USDA/RDA loan to buy a house, you will need to make a down payment. The size of the down payment will vary based on the loan program and the lender. For instance, with an FHA loan, you could put down as little as 3.5% of the borrowed amount (learn more). With a conventional or ‘regular’ mortgage (one that is not insured by the government), you’ll probably need a down payment of 5% or higher.
5 Things You Can Do Right Now
This article explains how to get approved for a home loan in general terms. Here are five specific things you can do to increase your chances of getting approved for a mortgage.
- Check your credit reports. Did you know you have three different credit reports? Did you know they contain a detailed history of your loans and credit accounts? It’s true. More importantly, the information in your credit report reports is used to produce your credit scores (see #2 below). If you plan to apply for a home loan in the near future, you should take a close look at your credit reports. Check them for accuracy. Dispute any mistakes you find through the bureau that produced the report. Start by visiting www.annualcreditreport.com.
- Maintain a good credit score. FICO credit scores — the one used by most mortgage lenders — cover a range from 300 to 850. The higher your score, the better your chances of getting approved for a home loan. You can maintain a high score (or improve a low one) by paying your bills on time and using credit cards sparingly.
- Save as much money as possible. You’ll need a certain amount of money in the bank to get approved for a home loan. First, there’s the down payment to consider. We talked about this earlier. Secondly, you’ll encounter some closing costs, and these can quickly add up to several thousand dollars. These days, some lenders want you to have additional funds in the bank, above and beyond the down payment and closing fees. These are known as ‘cash reserves.’
- Avoid major purchases. You can improve your chances of getting approved for a home loan if you avoid major purchases in the weeks before. By ‘major,’ I’m referring to anything that requires a credit card or loan. Purchasing big-ticket items can hurt you in two ways. First, it reduces those all-important cash reserves we talked about earlier. It also raises your debt-to-income ratio. Both of these things can harm your chances of getting approved. And speaking of debt ratios…
- Evaluate your debt situation. Earlier, we talked about the debt-to-income ratio, and how it can affect your ability to get approved for a home loan. It’s a good idea to measure your DTI before applying for a loan, just to see where you stand. You can find plenty of free debt-to-income calculators online. If your ratios are well above the general rules mentioned earlier (29% front end, or 41% back end), you should consider reducing your debt load.
Disclaimer: This article explains how to get approved for a home loan in 2013. This article takes the form of a general response to a reader’s question. The information contained in this article is offered for educational purposes only, and does not constitute financial advice. Most of the mortgage requirements discussed above are general rules and are not set in stone. Only a lender can tell you with certainty if you are qualified for their loan programs.