Finding the mortgage program that best fits your needs can make all the difference when deciding to buy or refinance a home. For example, an adjustable-rate mortgage (ARM) with a very low introductory rate might not be the best for you if the rate ends up doubling after the intro period. However, if you plan to stay in the house for less than 5 years, then a 5/1 ARM might be the best way to go.
How Your Debt-to-Income Ratio Impacts Your Chances of Getting a Mortgage
Did you know that the best mortgage lenders prefer individuals (or families) with a debt-to-income ratio that is less than 36%?
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This is based on a recent review published by Bankrate, a top research and banking industry publishing firm.
Let’s assume, for a moment, that your household makes $7,900 each month.
The mortgage lender, broker or loan originator will add up any monthly debt payments and include what your mortgage payment would be if approved for the loan.
So, let’s say that your current monthly debt payment is $1,700 a month, and your monthly mortgage payment will be $700 a month (if approved for the loan).
In the above case, your total future monthly debt payments will end up around $2,400 a month.
To calculate your debt-to-income (DTI) ratio, divide $2,400 by $7,900, resulting in a 30.37% DTI ratio.
Being that this DTI ratio falls below the “less than 36% threshold,” the top largest mortgage lenders will look favorably on this ratio.
However, what if your calculated threshold is above that 36% level? Does that automatically limit your ability to get a residential or commercial loan?
Although the best mortgage providers prefer to see a DTI that is below 36%, they’ll sometimes approve you for a mortgage loan if you have a higher DTI.
- There are a lot of other variables that lenders look at including your credit score and job history.
- As part of their loan origination methodologies and loan approval calculations, mortgage lenders realize that DTIs are never constant. For example, your mortgage payment is impacted by the price of the house, interest rates, and the property taxes for the city or region where the house is located in.
Tip: One way to reduce your DTI ratio before applying for a loan is to reduce your debt (reduce your outstanding credit card balance or student loans). You can also find ways to temporary increase your annual income (For example, sell things on Craigslist, eBay or Amazon and count these sales as “other income” for that year).__
Mortgage Pre-Qualification vs. Mortgage Pre-Approval
Consumers are sometimes confused on what the difference is between a pre-qualification and a pre-approval.
The section below provides information on the difference between these two key loan processing terms.
Mortgage Pre-Qualification: Getting prequalified for a mortgage gives you an idea of what your loan program (type of loan) and the estimated loan amount you could borrow might look like in advance. This also involves an assessment of whether your debt-to-income ratio fits the guidelines required by the mortgage originator. In addition, a pre-qualification gives you an informative estimate of how large of a mortgage loan a lender may be willing to offer you. With a pre-qualification, there is no formal agreement.
A pre-qualification does not appear on your credit report as an inquiry.
Mortgage Pre-Approval: This involves a formal agreement between you and the mortgage lender, in which the lender promises to offer you a mortgage loan within a particular period of time.
You’ll provide the lender with some key information (e.g., name and Social Security number) which will allow the lender to run your credit.
If the mortgage lender decides to approve your pre-approval application, then you'll get a commitment letter stating the exact amount of the pre-approved loan.
With a pre-approved commitment, the lender is obligated to provide you with the specified loan amount after you decide on your home. Although obligated, the lender can also set some pre-conditions that need to be met or maintained. For example, a condition might include, "So long as your credit score remains above ###, you'll get the stated loan amount."
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A pre-approval shows a home seller or agent that you have the funding lined up.
There is still additional processing that the mortgage lender needs to do.
However, the seller knows that you’ve been pre-approved and is able to act quickly when you decide on the home.
From a seller's perspective, a pre-approved prospect with a bank’s backing is a lot more attractive than a prospect that states that a buyer can purchase the house, in which case the seller has nothing but that person's word to back up the offer.
Sometimes, a pre-approval is a deciding factor for sellers who receive multiple bids.
The best mortgage lenders recommend not applying for a pre-approval until you are certain that you want to buy a home within a 90-day time frame.
Why? A pre-approval impacts your credit report. It shows up as an inquiry, and it is only good for a certain amount of time.
In addition, the best mortgage lenders normally frown on situations where they see a lot of inquiries on an applicant’s credit file within a short period of time.
They might assume that you’ve been applying for loans with other lenders and have been getting denied. Whether that is a correct or wrong assumption, you have to understand that no lender wants to take a risk on approving a loan for an applicant that everyone else has denied.
The general consensus is that when mortgage lenders see multiple applications (as shown by multiple inquiries on your credit file) reported in a short period of time, it can discourage them from giving you a loan.
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