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Buying a home is a major financial investment, and, for many people, the largest purchase they will make. To buy a home, you’ll likely need a mortgage for funding that you can pay off over the long-term.
However, not everyone will qualify for a mortgage. Learn more about the steps you can take to increase the chances that mortgage lenders will approve you.
Key Takeaways
- Before you apply for a loan, check your credit to understand how lenders will view you as a borrower.
- You can improve your credit score by making on-time payments and reducing debt.
- You can get your credit report from major credit bureaus at least once a year.
- Report any errors you see on your credit report immediately to the lender.
- The larger the down payment you put on a home, the more likely a lender will approve you for a mortgage.
1. Check Your Credit Report
Lenders review your credit report, which is a detailed report of your credit history, to determine whether you qualify for a loan and at what rate.
By law, you are entitled to one free credit report from each of the “big three” credit rating agencies (Equifax, Experian, and TransUnion) every year. You can use AnnualCreditReport.com to request your free copy, which you can get immediately in electronic format.
Review your credit report for errors and to get an understanding of your credit history, such as if you have a history of late payments or high credit utilization.
2. Fix Any Mistakes
Read your credit report closely to see if there are any mistakes that could negatively affect your credit. Look for potential errors such as:
- Debts that have already been paid (or discharged)
- Information that is not yours due to a mistake (e.g., the creditor confused you with someone else because of similar names and/or addresses, or because of an incorrect Social Security number)
- Information that is not yours due to identity theft
- Information from a former spouse that shouldn’t be there any more
- Out-of-date information
- Incorrect notations for closed accounts (e.g., it shows the creditor closed the account when, in fact, you did)
Consider checking your credit report at least six months before you plan to shop for a mortgage so you have time to find and fix any mistakes.
If you do find an error on your credit report, contact the credit agency as soon as possible to dispute the mistake and have it corrected. For additional peace of mind, consider using one of the best credit monitoring services to keep watch for any suspicious activity.
3. Improve Your Credit Score
A credit score is a three-digit number that lenders use to evaluate your credit risk and determine how likely you are to make timely payments to repay a loan. The most common credit score is the FICO score, which is comprised of different credit data:
- Payment history – 35%
- Amounts owed – 30%
- Length of credit history – 15%
- Credit mix – 10%
- New credit – 10%
In general, the higher the credit score you have, the better the mortgage rate you can get. To improve your score, check your credit report and fix any mistakes, and then work on paying down debt.
Setting up payment reminders so you pay your bills on time, keeping your credit-card and revolving credit balances low, and reducing your debt. Avoid making a major purchase while you are applying for a mortgage.
4. Lower Your Debt-to-Income Ratio
A debt-to-income ratio compares the amount of debt you have to your overall income. It’s calculated by dividing your total recurring monthly debt by your gross monthly income, expressed as a percentage. Lenders look at your debt-to-income ratio to measure your ability to manage the payments you make each month, and to determine how much house you can afford.
Lenders like to see debt-to-income ratios that are 36% or lower, with no more than 28% of that debt going toward mortgage payments (this is called the “front-end ratio”). In most cases, 43% is the highest debt-to-income ratio you can have and still get a qualified mortgage. Above that, most lenders will deny the loan because your monthly expenses are too high compared with your income.
To lower your debt-to-income ratio, and both are easier said than done:
- Reduce your monthly recurring debt.
- Increase your gross monthly income.
To reduce your monthly recurring debt, first cut back on purchases you make with credit. Look at where your money goes each month, figure out where you can save and make it happen. To increase your income, you can try to find a second job, work extra hours at your primary job, or request a pay increase.
5. Go Large with Your Down Payment
A large down payment can also help increase your chances of getting approved for a mortgage. The more money you put down, the more you reduce the loan-to-value ratio, which also increases your chances of getting the best mortgage interest rates.
The loan-to-value ratio is calculated by dividing the mortgage amount by the purchase price of the home (unless the home appraises for less than you plan to pay, in which case the appraised value is used).
Here’s an example. Say you plan to buy a house for $100,000. You put down $20,000 (20%) and seek a mortgage for $80,000. The loan-to-value ratio would be 80% ($80,000 mortgage divided by $100,000, which equals 0.8, or 80%). If you can put down $40,000 for the same house, the mortgage would now be just $60,000. The loan-to-value ratio would fall to 60% and it will be easier to qualify for the lower loan amount.
When you’re setting your down payment, remember that a 20% or larger down payment will also mean that you won’t be subject to a mortgage insurance requirement, all of which can save you money.
How Long Do You Have to Pay PMI?
You have to pay private mortgage insurance (PMI) on conventional mortgages in which you put down less than 20%. Once you have paid enough equity in the home (20%) of the home’s value, you are no longer obligated to continue paying the PMI.
What Credit Score to Mortgage Lenders Require?
Lenders have their own criteria for qualifying you for a mortgage, so the credit score you will need will vary from lender to lender. The higher your credit score, the better your interest rate. Many lenders like to see a score of 670 or higher, which is at least a “good” credit score.
Is it Better to Have a Co-Borrower on a Mortgage?
Another way to increase your chances of getting a mortgage is to include a co-borrower on the loan. In this case, a lender will factor in the co-borrower’s credit and financial situation when determining whether to approve you and for what interest rates.
The Bottom Line
Tighter lending practices have made it more difficult to secure a mortgage. The good news is that there are steps you can take to improve your chances of qualifying for a loan, especially if you start early. Start the process by checking your credit report and fixing any mistakes, and then work on improving your credit score, lowering your debt-to-income ratio, and actively saving for your down payment.