By Brandon Cornett | © 2014, all rights reserved | Duplication prohibited
Things have changed in the lending industry over the last few years. This should come as no surprise to you. But you may be surprised by how much things have changed. It's harder to get a home loan today, in 2011, than it was during the housing boom. Back then, nearly anyone could qualify for a mortgage. But not anymore. In the current market, home buyers need to have their financial houses in order, more so than ever before.
So just how hard is it to get a home loan these days? What do lenders expect from you, as a borrower? You'll find answers to these questions and more below.
Home Loans - Past, Present and Future
Before we discuss the current state of the mortgage market, we need to cover a bit of history. It will help you to understand why lenders have such strict requirements these days. I promise to keep it brief.
During the housing boom, mortgage lenders were taking some extraordinary risks. They were giving home loans to people who had no business taking on such a debt. The industry lingo for this is "reasonable expectation." Lenders should only give loans to people when there is a reasonable expectation they will pay it back (based on their borrowing history and current financial situation). Responsible lending fell by the wayside during the housing bubble.
You know the rest of this story. All of those bad loans went bust, and they brought the entire housing market down with them. As an added bonus, we got a full-scale economic recession.
Risk Reduction is the Current Trend
You can already see why it's hard to get a home loan these days. Lenders today are less willing to take on risk. So they're doing more to assess that risk up front, before approving borrowers for mortgage loans. They are requiring higher credit scores, less debt, more documentation, and larger down payments. These are the factors that have changed the most in recent years. And if you want to get approved for a mortgage loan in 2011, you need to understand each of them.
The media is always saying how different the lending industry is today, and how much harder it is to get a home loan. In truth, we have simply returned to the standards that used to be in place. Some readers may be too young to remember this. But before the days of "easy credit" and housing bubbles (i.e. before the mid 1990s), it was hard to qualify for a mortgage loan. You had to save up some money for a down payment. You needed to have excellent credit. You had to document your employment history for the last two years.
Sound familiar? These are the same standards lenders have returned to in 2011. We have simply hit the reset button. Here's how it affects you as a home buyer.
How to Get a Mortgage Loan in 2011
I promised to keep the history lesson brief. So let's move forward now. What does it take to get a home loan in the new economy?
When you apply for a mortgage loan, the lender will look at many different factors to measure your risk. I often tell first-time buyers to imagine themselves walking into a bank with a t-shirt that says "RISK" in big bold letters. That's basically how the lender sees you. But what they really need to know is how much risk you bring to the table.
In order to determine this, they look at several key factors:
- The amount of total debt you have (credit cards, car loans, etc.)
- Your gross monthly income, relative to your monthly debts
- Your FICO credit score at the time you apply
- How much of a down payment you have
These aren't the only things the lender will examine. But they are four of the most important factors that will determine whether or not you can get a home loan. So let's look at each one in more detail:
1. Your Debt Level
Debt has become a lot more important in recent years. Lenders today are very concerned with the amount of debt a borrower has, particularly with the mortgage loan added in. They are
also less willing to bend the rules for debt-to-income (DTI) ratio.
I speak from experience here. My wife and I went through the mortgage underwriting process in May of 2011. We both had excellent credit scores above 800, and a long history of paying our debts on time. We also had sufficient funds for the down payment and closing costs. But the lender still had a problem with our debt ratios. Long story short, we had to pay off one of our credit cards to lower our DTI ratio. Once we did that, they finally approved us for the loan. The whole process was a real eye-opener, and that's why I'm sharing it with you.
Lenders are most concerned with your total debt. which includes your housing costs. This is also referred to as your "back-end ratio." To come up with this number, they will add your estimated housing debt (the mortgage payment you'll end up with) to your other debts (such as credit cards and car loans). Next, they will compare this combined number to your gross monthly income. The end result is a percentage that could make or break your chances of getting a home loan.
For example, if you will be spending half of your gross monthly income on your combined debts (including the mortgage payment), then your back-end debt ratio would be 50 percent. This is too high by most lenders' standards. The limit will vary from one lender to the next. Most of them want to see a back-end DTI ratio below 40 percent.
Here's the bottom line. If you want to get a home loan in today's lending environment, you need to take a look at your debt load. This is another reason to get pre-approved for a mortgage. This process helps you identify any problems you have, in terms of loan approval.
2. Your Income Situation
We talked a lot about your income in the previous section. The lender will consider your income by itself, to ensure you have the capacity to repay the loan. But they'll also weigh your income against the current amount of debt you have. This is the debt-to-income ratio we discussed earlier.
Here's the big difference for 2011. In the past, you could simply "state" your income to the lender. These were referred to as stated-income loans. In a derogatory sense, they were also called "liar loans." But those days are gone. Today, lenders must obtain proof of income through tax records, bank statements and/or pay stubs. The secondary mortgage market requires this kind of up-front verification. So if the lender wants to securitize and sell their mortgage loans into the secondary market (and most of them do), they have to play by the new rules. And one of those rules is to verify income before granting an approval.
How much income do you need to get a home loan in 2011? Refer to the debt ratios under section #1 above. It all comes back to the DTI limits.
3. Your FICO Credit Score
I've written some in-depth articles on this particular topic (see links below), so I won't repeat it all here. You will probably need a FICO credit score of 620 or higher to qualify for a conventional mortgage loan. You might be able to get an FHA home loan with a score below that.
Keep in mind these rules are not written in stone. It varies from one lender to the next. This is another reason to get pre-approved for a loan. The lender will tell you if your score is too low. Then you can focus your efforts on improving it, if necessary.
Also keep in mind that your FICO score affects the interest rate you receive. If you want to qualify for the lender's best rates, you'll need to have excellent credit.
Disclaimer: This article explains how to get a home loan in the tougher lending environment we are seeing today. Please note that this tutorial is for educational purposes only. You should not view this information as the final word in loan approval. Only a mortgage lender can tell you whether or not you meet their particular guidelines for approval. For this reason, we recommend that all home buyers get pre-approved for a mortgage. It's the next logical step if you want to find out where you stand.