Removing the Mystery from … Qualifying for a Mortgage
What are the primary factors involved in qualifying for a mortgage?
Qualifying someone for a home loan can range from the straightforward to the very creative, as a number of factors must be taken into account.
At Apple Street Mortgage, we do a quick qualifying analysis by means of the “ACID” test – a useful acronym for “Assets”, “Credit”, “Income”, and “Debt and Downpayment” (the “D” serves a dual purpose). Just because your application may be weak in one of these areas doesn’t mean that you won’t qualify for a loan, as strengths in some of the other areas can be used as “compensating factors” to qualify. We’ll visit each one in turn with a general overview.
Assets. This refers primarily to the money that you have in the bank, stock market, CD’s, retirement accounts etc.. Usually the simplest assets to document are those in your bank account. Retirement account assets may also be used for qualification, but usually only about 70% of these funds are allowed. Lenders typically look for enough liquid assets to cover two months of the monthly payment on your mortgage (which includes PITIMI (Principal, Interest, property Tax and Insurance escrows, and Mortgage Insurance) though this may vary.
Credit History. With your full name, address, and SSN, we can run your credit report in a few minutes to get your credit score and list of creditors. Information from the three major credit bureaus is usually combined in what is called a “tri-bureau credit merge”. Scores in the 700’s and 800’s will place you in the upper percentiles of borrowers and qualify you for the best terms. Scores in the mid to upper 600’s will usually still put you in pretty good shape. Scores in the lower 600’s are more marginal and scores below 600 will probably place you in the “subprime” category where you may be subject to a higher interest rate. These are not hard and fast rules but they do serve to give you some idea of where you stand. Your lender will also look closely at such items as late payments (late mortgage payments are especially frowned upon), collections, bankruptcies, and foreclosures. Credit issues can get complicated very quickly so it is best to have us analyze your credit report for you early on in the home loan process.
Income. This refers most commonly to your gross income from your job. But it may also include rental income, investment income, alimony, Social Security, and other sources. Typically, a lender looks for two years of income in the same line of work and may require pay stubs and a W-2. Self-employed borrowers are slightly higher risk but will often be approved with the same favorable terms as W-2 employees as long as you can show a year or two of your income tax returns. Bonus income and commissions can be used as well, though additional documentation is usually required to show a history of having received this income. Programs are also available for self-employed borrowers who are unable to readily document income.
Debt. This is the money that you owe on your mortgages, credit cards, student loans, car loans etc… Your lender is usually more interested in your monthly payment than the total amount owed. Two “ratios” are examined in qualifying a borrower. The “front-end ratio” refers to your PITIMI monthly payment (see “Assets” section) relative to your gross monthly income. Your “back-end ratio” adds your non-mortgage monthly debt into the mix. For example, if monthly PITIMI is $1500 and your gross monthly income is $5000, you arrive at your front-end ratio by dividing 1500 by 5000 and converting to a percentage – in this case 30%. For the back-end ratio, you add the rest of your monthly debt (let’s say $500) to your PITIMI mortgage debt ($1500) to arrive at $2000. $2000 divided by $5000 is 40%. So your front ratio is 30% and your back ratio is 40%. It used to be that the standard qualifying ratios where 28% and 36%, meaning that anything above these percentages was too high and could disqualify you. But with the advent of automated underwriting models that we use, the higher ratios are very often accepted!
Downpayment. This is maybe the biggest factor of all. Obviously a borrower who is putting 50% down on their home is a better risk for a lender than someone who is putting only 5% down. In mortgage terminology, your downpayment translates into a “Loan-to-Value” or LTV which is simply the loan amount over your property value expressed as a percentage. A downpayment of 5% translates to a LTV of 95%. A lot of sins in the other areas of the ACID test are forgiven with a high downpayment (or low LTV)! Keep in mind that your lender may require mortgage insurance (which protects the lender, not the borrower in the event of default) if your LTV exceeds 80%.
Again, we’ve just touched on the primary factors involved in qualifying. Each loan and borrower has a different set of circumstances. We will analyze all of these factors for you so that you can leverage your assets in the most effective way possible.
What is the difference between prequalification and preapproval?
These terms are often used interchangeably but they usually mean quite different things which are important to know – especially when you are shopping for a new property.
A “prequalification” is usually a quick over-the-phone calculation performed by your lender that prequalifies you for a loan. It is simply an opinion based on the factors discussed above. A prequalification letter which we can provide to you is helpful in shopping for a new property, but a "preapproval" letter is better.
A “preapproval” is usually given after you have submitted a formal loan application with a credit analysis. A prequalification is an opinion, a preapproval is a decision to extend credit. The "preapproval" may have a number of "subject-to" conditions associated with it such as a satisfactory appraisal, asset verification, job verification etc.
At Apple Street Mortgage, we run most loan applications through a computer automated underwriting system and can get preapproval subject to conditions/verifications for our borrowers within minutes. We will then have a human underwriter review the conditions (appraisal, bank statements etc.) along with your original loan application before issuing a more formal loan commitment.
Unfortunately, a loan commitment from a lender can still have conditions, the most common being a last-minute verification of employment. It's simply a reality of the business (meant to enlighten - not frighten) that a lender may not follow through on their "commitment" if they determine a few days before closing that you've lost your job. For this reason, it is best for a borrower to make the loan commitment date and the closing date the same! The seller may not be agreeable to this, but you should discuss this with your real estate agent and understand all of the ramifications of your decisions.
Many lenders require an entire laundry list of documentation, but our experience (with the help of the latest technology) enables us to do many of our loans with very limited documentation, saving you a lot of time and hassle. Sometimes only a bank statement is required!
With all the different terminology and variables involved, the important thing to remember is that you should always work with a trustworthy professional with experience. Putting your loan in the hands of someone who is not an expert in their field can cost lots of time, money, stress, and possibly your loan!