5 Things to Do (and Avoid) Before Applying for a Mortgage
It's harder to qualify for a mortgage loan these days. New regulations require lenders to verify every aspect of a borrower's financial background, before making the loan. Additionally, most lenders have tightened their underwriting criteria in response to losses suffered during the housing crisis.
As a borrower, you should avoid doing anything that might harm your chances of getting approved for a loan. Here are five things in particular you should avoid before applying for a mortgage -- followed by five things you should do:
1. Taking out other loans
Auto, personal, and student loans all have one thing in common. They increase your total debt load. As a result, they can also affect your chances of being approved for a mortgage.
When you apply for a home loan, lenders will consider the amount of debt you currently have. They will compare your recurring monthly debts to your gross monthly income. This is known as the debt-to-income ratio, or DTI. It has become one of the most important qualification requirements for borrowers in the current lending environment.
The last thing you want to do before applying for a home loan is to increase your DTI ratio. This can hurt your chances of getting approved. So, if you plan to apply for a mortgage in the near future, try to avoid taking out other loans or credit lines. At the very least, put them off until after you've been approved.
2. Racking up credit card debt
We just talked about the importance of the debt-to-income ratio when applying for a mortgage loan. Credit card balances are included in this calculation as well. Carrying too much credit card debt is one of the most common reasons for mortgage rejection these days. It makes you more of a risk, in the lender's eyes.
It's generally wise to limit credit card use before applying for a mortgage loan. Racking up additional debt by using those cards will simply drive up your DTI ratio. It can also lower your credit score by increasing your overall "credit utilization ratio." This is one of the five factors that influence your credit score.
3. Missing credit card payments, car payments, etc.
Lenders use your credit score as a risk-assessment tool. A higher score indicates a lower risk for the borrower. And the reverse is true -- a lower score indicates a higher risk for the lender. So you want to do everything possible to protect your credit score when shopping for a mortgage loan.
Your payment history accounts for 35% of your overall score -- more than any other single factor. In fact, a single late payment can drop your score by 50 points or more, depending on the circumstances. That's the last thing you need before applying for a mortgage. So avoid missing payments.
4. Blowing your savings
You will encounter certain out-of-pocket costs when using a mortgage loan to buy a house. First, there is the down payment to consider. Unless you're using a VA or USDA home loan (both of which offer 100% financing for borrowers), you will have to make a down payment of some kind. It might be 3.5% for an FHA loan, or 5% to 10% for conventional financing.
You'll encounter closing costs as well, and these can amount to thousands of dollars above and beyond the down payment.
Some lenders will want to see additional cash reserves in the bank as well, especially if you are viewed as a higher risk borrower for some reason.
To improve your chances of qualifying for a mortgage, you should save as much money as possible. Before applying for a mortgage, it's best to avoid large purchases that deplete your savings. It might be tempting to plan that beach vacation, or to buy that new flat-screen TV you've always wanted. But these things chip away at your much-needed cash reserves. Put off such purchases until after you've secured your loan.
5. Changing jobs, or taking a leave of absence
Mortgage lenders want to see a history of steady employment and income. In most cases, they'll require steady employment for at least two years. Of course, if you receive your income from non-employment sources such as an annuity, this becomes something of a moot point. But for a typical home buyer / borrower, employment is a key qualification item during the mortgage application process.
If you change jobs within the same field, and secure an equal or greater level of income, you might not have any problems. But if you make a major career change, or if your income decreases from your previous position, you could hit some snags during the underwriting process.
The ideal scenario is to maintain the status quo, as far as your employment goes. Sometimes we have no control over such things. But if you do have a say in the matter, postpone your career changes until after you received financing -- unless it comes with a big fat pay increase.
What You Should Do Before Applying for a Mortgage
We've talked about what to avoid. So what should you actually do before applying for a mortgage loan? The opposite of everything listed above, of course. Here's a checklist of smart choices:
- Put off all other forms of financing (auto, personal loans, etc.) until after you've closed on the home. If you over-extend yourself with other forms of debt, you could have trouble getting approved for mortgage financing.
- Limit your credit card usage. Keep those cards in your pocket for now. Resist the urge. Use them only as a last resort, and sparingly. Keep your balances down.
- Make darn sure you pay all of your bills on time, especially the ones that show up on your credit report. A single missed payment could blow your chances of getting a mortgage loan, if it gets reported to the reporting agencies.
- Save as much money as possible, as early as possible. The more the better. You'll need it for your down payment (maybe), your closing costs, and possibly additional cash reserves. And that's just to qualify for the loan. You'll also need money to cover moving expenses, furnishings, etc.
- Keep things steady on the employment front. Keep your current job and avoid switching, until after you've been approved. The exception to this rule is when a job change results in a significantly higher income, which could improve your chances of getting a loan. Aside from that, the status quo is best.
This article explains some of the things you should do before applying for a mortgage loan, and some of the things you should avoid. You can learn more about these topics by following the hyperlinks spread throughout the article. You can also use the search tool located at the top of this website to access our library of more than 400 mortgage articles!