With interest rates at historic lows, you may have wondered whether you should pull the trigger on buying a home, buying an investment property. or refinancing a mortgage. Even though interest rates and home values are low, lending standards are higher than ever. In this article we’ll explore what it takes to qualify for a conventional mortgage in the current credit environment.
How to Qualify for a Mortgage or Refinance
Before you apply for a new mortgage or a refinance. you need to make sure that you’re in good financial shape. If you don’t have the financial chops to qualify or have more debt than is allowed for a refinance, for instance, going through the application process will be a waste of time. It’s possible that you could be approved for a loan, but at an outrageously high interest rate.Each lending institution has different underwriting guidelines for evaluating a potential borrower; and I’m sure you know that due to the credit crisis, lending standards are now tougher than ever. When you apply for a home loan, you’re generally judged on the following five categories:
Debt. Will you have enough cash flow left over to make a mortgage payment after paying your other liabilities.Savings . Do you have enough for a down payment plus more cash on hand to pay your mortgage if your income is reduced?
Financial ratios. How much debt do you have relative your income?
In addition to those five qualification categories, you need to have at least 20% equity to refinance a primary residence. Equity is the difference between how much a property is worth and the amount that you owe on it. It’s based on your home’s current appraised market value, not what you paid for it. So if your property is worth $250,000 today and you still owe $225,000, you have equity of $25,000 which comes to 10%. In most cases, that wouldn’t be enough equity to qualify for a refinance because, as I mentioned, 20% is usually the magic number. Some lenders may even require you to have more than 20% equity to refinance an investment property .
How to Prepare for Getting a Mortgage
If your FICO score is below 600, you probably won’t be approved for a conventional loan.Here’s a checklist with essential tasks to accomplish before you contact a mortgage lender:
is competitive. How much house you can afford largely depends on your mortgage’s interest rate and term. If you plan on keeping your home for the long-term, getting a fixed-rate loan is usually best. A longer term (like 30 years) lowers the monthly payment, but also comes with a higher interest rate. That means over the life of a 30-year mortgage you pay substantially more interest as compared to a 15-year mortgage.
Calculate your debt-to-income ratios to make sure you won’t exceed the typical loan underwriting requirements. Lenders want to know the percentage of your monthly gross or pretax income that would be used to pay the mortgage—generally it can’t exceed 28% to 30%. To run the numbers yourself, use the Mortgage Calculator at mortgage-calc.com. But don’t forget to add in the estimated property taxes and homeowners insurance. Ask a Realtor or an insurance agent to estimate those costs for you. The total mortgage obligation is known as the PITI payment, which stands for principal, interest, taxes, and insurance. For example, if your PITI is $1,500 and your monthly income is $5,000, then your mortgage-to-income ratio is 0.30 or 30% ($1,500 / $5,000 = 0.30 = 30%). As I mentioned you’ll generally need to stay below 30% to be approved.
Lenders also evaluate the percentage of your income that would go toward all your monthly obligations including the mortgage. credit cards. student loans. auto loans. and so on. Your total debt-to-income ratio normally shouldn’t be higher than 36% to 40%. However, as I said earlier, each lender has a different standard and having an excellent credit score or shelling out a large down payment may give you some leeway with both of those financial ratios.
What Documents Do You Need for a Mortgage?
If you’ve worked through this checklist and you feel like you’re ready to apply for a loan, start gathering your paperwork. You’ll need several months of pay stubs and W-2 forms from the past two or three years. If you’re self-employed or have a variable income, lenders will ask for your tax returns from the last two or three years. Also make copies or print out bank and investment account statements for the past six months.
What is a VA Mortgage Loan?
If you don’t qualify for a conventional loan and you’re a veteran, on active military duty, a Reservist, or in the National Guard, you may be eligible for a VA loan. You don’t have to come up a down payment for a VA loan because you’re allowed to finance 100%. They’re issued by approved lenders and guaranteed by the U.S. Department of Veterans Affairs. For more information visit homeloans.va.gov .
What is an FHA Loan?
Another alternative to a conventional loan is one insured by the FHA, or Federal Housing Administration. Lenders approved to offer FHA loans can be more flexible with their approval standards and require a lower down payment. Get more information at hud.gov and see what home-buying programs are available in your state .
A quick and dirty tip for buying a home or investment property is to get prequalified for a loan before you start shopping. That lets a seller or real estate agent know that you’re serious about making a deal. Talk to several lenders or mortgage brokers and shop carefully for a product with the lowest interest rate and total fees.
The podcast edition of this tip was sponsored by Matrix Direct. They’ve helped over 4 million people get affordable term life insurance so their loved ones are protected. Visit matrixdirect.com/moneygirl and save up to 75% or more on term life insurance today.
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