What Do Lenders Look at When I Apply for a Mortgage?

Reader question: "I am a first-time home buyer, and I've been reading up about the mortgage process. I'm still not clear on what the lender will check after I apply for a loan. What do mortgage lenders look at when somebody applies for a mortgage?"

Everything the lender reviews will fall into one of two categories -- the property and the borrower. The lender will look at everything related to your financial situation. They want to know how much money you make, how much debt you have, and how much risk you bring to the table.

As for the property, the lender wants to know how much the home is worth in the current market. They will also check to ensure the title is clear and ready to be transferred to the buyer.

How a Lender Evaluates a Borrower

Here are four things the lender will look at when you apply for a mortgage loan. The motivation behind all of these things is the same. The lender wants to know how likely you are to repay the loan. It's all about measuring risk.

1. The lender will check your credit score.

When you apply for a home loan, the lender will check your credit score to see how you've borrowed and repaid money over the years. They used to check the actual credit report. But this was labor intensive. So a company called Fair Isaac Corporation (FICO) created a scoring model to convert the credit report data into a numerical score.

Today, the lender can look at a single number to find out how responsibly you have used credit in the past. This number is referred to as your FICO credit score. FICO scores run from 300 to 850. The higher your score, the better your chances of getting approved for a loan.

Just remember, your score is determined by the information contained in your credit reports. So it's a good idea to check your reports at least 30 days before applying for a loan. That way, you can correct any errors you might find.

Lenders didn't look at credit scores much in the past. In fact, if you had steady employment and income, you could've qualified for a mortgage regardless of your credit. But this has all changed in recent years. Today, the credit score is one of the key components of the underwriting process.

The lender will look at your credit score soon after you apply for a mortgage loan. This might happen during the pre-approval process (before you've found a house), or during the final approval (after you've made an offer on a house). Sometimes, the mortgage lender will look at your credit score twice. They will certainly check it up front when you apply for a loan. But the underwriter might check it again later on, during the underwriting process.

Here's an article that explains what credit score you might need to get a mortgage loan these days.

2. The lender will look at your employment history.

If you just started a new job, you may have trouble getting approved for a mortgage loan. Lenders have become fairly strict about this requirement over the years. Today, most lenders want to see at least two years of continuous employment at the time you apply for a loan.

If you moved from one job straight into another within the last couple of years, they might make an exception. But if you have gaps in your employment history during the last two years, it's going to raise a red flag. This is another thing the lender will look at when you submit an application.

Learn more about the employment requirements for mortgage loans.

3. The lender will consider your income level.

Your income is obviously important to the lender. They want to make sure you make enough money each month to cover your mortgage payments, in addition to your existing debt obligations. The lender will look at your pay stubs for at least the last couple of months. They will also verify your earnings through your tax documents.

How much money you earn will determine two things:

  • First, it will determine whether or not you get approved for the mortgage loan. If you're already spending half of your monthly income on debt obligations, you probably won't qualify for a home loan.
  • Your income will also determine the size of the mortgage you can get.

The second factor will vary from one lender to the next, and also based on the type of loan you use. So there's no way I can give you a specific number or formula. But I can give you some specific numbers for your debt to income ratio…

4. The lender will check your current level of debt.

Many first-time buyers are surprised to find how much their debt influences the lender's decision. This is a major consideration from a mortgage lender's perspective. The debts themselves are not the problem. It's the amount of debt that can cause problems when you apply for a mortgage loan.

Lenders refer to this as your debt-to-income ratio, or DTI. This number, expressed as a percentage, indicates how much of your monthly income is going toward debt obligations.

If the lender determines you'd be spending one fourth of your income on your mortgage payments, credit card debt and car payments, then you have a back-end DTI ratio of 25%. This is a relatively low debt-to-income ratio, so it would help you qualify for a mortgage loan.

On the other hand, if you'd be spending well over half of your monthly income on combined debt, the lender might turn you down

I mentioned the term "back-end" ratio above. Here's what it means:

  • Your front-end debt ratio only considers your mortgage-related debt (monthly mortgage payment plus property taxes, homeowners insurance, and HOA fees).
  • Your back-end ratio considers your mortgage debt in addition to all other forms of debt you have (credit cards, car payments, student loans, etc.).

You'll often see this expressed as two numbers with a slash between them. For example, a lender might tell you that their DTI limits are 31/45. This means that your debt-to-income ratio can be no higher than 31% on the front end (mortgage debt only), or 45% on the back end (all debts combined). This is something the lender will look at when you apply for the mortgage.

FHA loans allow for slightly higher debt-to-income ratios than conventional mortgages. If you use the FHA program, you might get approved with a back-end DTI ratio as high as 55% (or even higher). If you use a conventional mortgage loan that's not insured by the government, your back-end DTI will probably be capped at 45%. This means you can spend no more than 45% of your monthly income on combined debt obligations.

See also: FHA vs. conventional mortgage loans

The Lender Will Look at the Property As Well

Everything we talked about above relates to you as the borrower. But the lender will also look at the home you are buying. They do this through the appraisal process, as well as the title search.

When you apply for a mortgage loan, the lender will look at the current market value of the home. They will compare this value to the amount you've offered to pay for the house.

  • If they determine the house is worth at least as much as you have agreed to pay, you're in good shape.
  • But if they determine that the property is worth less than you've agreed to pay, they might withhold the loan.

Remember, the mortgage lender usually has more at stake than the borrower. If you buy a house with a 10% down payment, it means the lender has a 90% stake in the property. For this reason, they want to make sure the home is worth the amount you have agreed to pay. They will do this by sending a professional home appraiser out to look at the property.

Video: The home appraisal process explained

Granted, they won't have a property to look at if you're just getting pre-approved for a loan. In this scenario, you're working with the lender to determine how much you can borrow. You're doing this before you start the house-hunting process. But when it comes time for the final approval of the loan, the lender will look at the appraised value along with the actual purchase agreement.

The mortgage lender will also perform a title search to make sure there are no other claims to the property. For example, if a housing contractor placed a lien against the property because they weren't getting paid by the builder, the lender would want to know about it. The title must be "clear" before the mortgage can go through. There must be a clear chain of title (or ownership) from the current owner to the new one.

This article explains what a lender will look at when you apply for a mortgage loan. Please note that this list is not all-inclusive. There are other considerations during the loan-approval process. But we have covered some of the most important items above. If you would like to learn more about this topic, follow the links provided in the article or use the search tool at the top of this page.