The Mortgage Approval Process in 2011
If you're planning to buy a house in 2011, and you need to use a mortgage loan for part of the financing, you should prepare yourself. The mortgage approval process has gotten a lot tougher over the last few years. You probably already know this. The media are constantly talking about the tougher lending standards in place today.
But you may not know how tough it is. And that's what I'd like to talk to you about today.
I rewrote this article in May 2011, while I was going through the mortgage approval process for myself. We were buying a house in the San Diego area, using a VA loan for the purchase. Now you might think lenders would go easier on borrowers using a VA loan, since the loan is guaranteed by the federal government. This was not the case at all. I've used both conventional and government-backed mortgages in the past, and I can tell you that this approval process was harder than anything I've been through before.
I don't tell you all this to discourage you. I just want you to be prepared for the underwriting process you're going to face. So let me speak frankly...
Mortgage Approval Criteria
When you apply for a home loan, the lender will look at dozens of factors pertaining to your financial picture. But there are three things in particular that will affect your chances of mortgage approval:
- Your credit score
- Your debt-to-income ratio
- Your down payment
If your FICO credit score falls below 640, you're going to have a harder time getting approved for a loan. I wouldn't say it's impossible to get an approval with a score below 640 -- just harder. If your score falls below 600, you might be out of luck.
The FHA loan program has a minimum cutoff of 500 for credit scores, but you still have to apply for one of these loans through a regular lender. And those lenders will impose their own guidelines on top of the minimum guidelines used by the FHA. These are referred to as "overlays," by the way.
Before you get into the mortgage approval process, you should check your credit score. It will affect your loan approval for one thing. But it also influences the interest rate you receive on the loan. So you want to know where you stand, and make improvements if needed.
Lenders are being pretty strict with debt-to-income (DTI) ratios these days, too. This is a percentage that shows much of your gross monthly income is going toward various debts. For example, if you're spending nearly half of your income to cover your debts, your DTI ratio would be 50 percent.
During the mortgage approval process, our lender told us our back-end debt ratio was too high. The "back-end" ratio includes your mortgage payment plus all of your other debts (credit cards, car payments, etc.). So they gave us a conditional approval. They said, "We will approve you for this loan, but you need to pay off this credit card first."
The card had a $12,000 balance on it, so paying it off was no small feat. Fortunately, we had enough money saved up to satisfy this condition. It lowered our debt ratio enough to secure the mortgage approval.
I'm not saying this will happen to you. It depends on where you are right now, in terms of your debt ratios. As far as mortgage approval goes, mortgage lenders are most concerned with the back-end ratio. But you can't calculate that until you know how much your mortgage payment will be.
In the meantime, you can calculate your front-end ratio to see where you stand. To do this, you would simply divide your monthly debts by your gross monthly income. You can leave your current rent or mortgage payment out of this equation. Your front ratio only includes non-housing related debts.
If your front ratio is higher than 30 percent, you might hit some snags during the mortgage approval process. Lenders prefer to see a front-end ratio below 29 percent (though this number is not written in stone).
Your down payment will tie into the other things we discussed above. The more money you put down, the more flexible the lender will be with your other criteria. For example, they might be willing to bend their rules on DTI ratios if you plop down 20 percent. On the other hand, a smaller down payment brings a higher risk for the lender. So they'll be more strict with their credit, debt and income requirements.
In closing, I'd like to talk about cash reserves and how they relate to the mortgage approval process. The term "cash reserves" refers to extra money you have in the bank. Some lenders will require you to have extra funds in the bank at closing, to cover your first few mortgage payments.
It's kind of a silly requirement when you think about it, because nothing guarantees you'll spend that money on your monthly payments. You could go out and buy a car with that money, two days after closing on the loan. So I'm not sure why some lenders obsess over the cash-reserve requirements. But I digress...
This is something you need to ask about in advance. Why? Because it's not always disclosed by the lender, the way it should be. We used Bank of America for our VA loan (and yes, I have regrets about this in hindsight). We were familiar with cash reserves, so we asked them about this up front. We were told that the VA loan had no requirements for cash reserves, so we wouldn't have to worry about it. That was good news.
But then later in the mortgage approval process -- only nine days before our schedules closing date -- the lender came back and said we did not have enough money in the bank. "You need to have six month's worth of mortgage payments in cash reserves, in order to close." We specifically asked them about this in advance, and they misinformed us. So there we were, only days before closing with a huge obstacle that wasn't there before.
This is why you need to proactive about asking questions, and finding out exactly what you need to have on closing day. Ask them more than once. Get it in writing. Tell them you want to know about all of your requirements for closing, including any cash-reserve requirements they might have.
If you want to learn more about the mortgage approval process and how it has changed, check out this informative article. I hope this gives you some additional insight into the current lending environment. Good luck.