Mortgage Approval: What criteria are considered?

Posted by  on Dec 30, 2010
 

When you apply for a mortgage, several important criteria will determine the success of your application. These include your credit rating and income to debt ratio, as well as other factors that determine the size of the mortgage you can afford as well as your chances of being approved at all.

Two Crucial Criteria

For mortgage lenders, mortgages are all about assessing a borrower’s level of risk before agreeing to grant them a loan. To assess the level of risk, mortgage lenders evaluate two major factors: the ability of a borrower to repay their loan, and their willingness to pay.

Ability to Pay

The ability of a borrower to repay a mortgage is evaluated through an investigation of their monthly income, assets, and monthly debt. This requires that you supply a lender with a substantial amount of financial information and documentation. A mortgage lender may require any or all of the following information, depending on your circumstances:
   · Federal tax returns for the last two years.
   · Pay stubs for the last one to two months
   · Employment details for the last two years, including employment dates and monthly income (gross).
   · Supporting information for any other income and assets you want to be included in your assessment, such as statements or books for savings accounts, IRA or 401K plans, and investments such as stocks and bonds.
   · Financial statements for your business if you are self employed; these must be prepared and signed by a certified accountant.
   · Recent statements of payment for your current creditors”these documents must include the name and address of the creditor, as well as the current balance of the account. This includes credit card debt, car payments, student loans, and any other current debts.
   · If you have any current or past delinquent debt payments, you must include letters explaining the reasons for non-payment.
   · If you have a current mortgage or are paying rent, up to twelve months worth of payment verification must be included.
   · If you are paying or receiving child support or alimony, a verified copy of the alimony or child support agreement must be supplied.
   · If you have been bankrupt at any time in the past, copies of any supporting documentation must be included, as well as an explanation of how you came to be declared bankrupt.
   · If you are selling your current property or building a new house, you must provide contracts of sale for the current home, or house plans and costs for the property you are building, as well as your construction contract and proof of ownership of the lot where your house is being built.

With all the required documentation in hand, your lender will then calculate your ability to repay a mortgage. To do this, they calculate your monthly income and monthly debt totals, and then use this information to work out your income to debt ratio. In most situations, if your monthly debt is equal to or less than 36-40% of your total monthly income, there will be no problems with this aspect of your eligibility assessment. However, because most lenders also prefer that your total property expenses, including taxes and insurance as well as mortgage payments, total less than around 30% of your monthly income, they will also take into account how much you wish to borrow.

Willingness to Pay

A lender’s evaluation of your willingness to pay a mortgage is based mainly on your credit report, as well as how you have handled not only any previous debts and loans, but also ongoing monthly expenses such as utility, rent or any previous mortgage repayments. This is where having a good credit report really makes a difference, as your credit rating can determine not only your mortgage eligibility, but also how good a mortgage interest rate you can get. A good credit rating indicates that you are a low-risk mortgage applicant, and therefore allows you to take advantage of lower interest rates.

Increasing your Mortgage Eligibility

Often, mortgage applicants may fall short in terms of either their ability or willingness to repay a loan. However, you can often make up the shortfall if your strength lies in other areas. For example, a very strong credit rating can often make up for a weak income to debt ratio. Similarly, if you can demonstrate a consistent work history”if, for example, you have worked for the same employer for several years”a lender might consider you a lower risk applicant than someone with a higher income who has changed jobs several times.

In some cases, you may be offered a mortgage, but at a higher interest rate than you can realistically afford, or your application may be refused on the basis of a poor credit rating or low income to debt ratio. In such situations, it’s usually more prudent to wait and save for a larger down payment, or try to repair your credit rating, rather than opting for a sub-prime mortgage that will typically incur a very high interest rate.

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