Home ownership is one of the cornerstones of the American Dream. But for one reason or another, many people find that the dream is beyond their reach. It doesn't have to be this way. By understanding what affects your chances of getting a mortgage, you can work to improve your odds for success.
Here are three of the most common barriers to home ownership, along with practical advice for overcoming them.
1. You can't qualify for a mortgage
If your mortgage application has been denied, the first step is to figure out why. Lenders look at several factors when deciding whether to approve your loan, including your credit score, your income, and the amount of debt that you have.
The most common reason mortgage applications are denied is a poor credit history. If you have a number of late payments or repossessions on your credit report, you might find it difficult to get any loan until you demonstrate a greater sense of financial responsibility. In that case, it's a good idea to work on rebuilding your credit before you reapply for a mortgage.
If you've been turned down for poor credit and you believe there has been a mistake, it's a good idea to pull your credit report and check for errors or fraudulent accounts. If you find any, you should put a fraud alert on your credit report and immediately notify the credit bureau and the financial institution so that they can correct the mistake. Then, when the matter is cleared up, you can try reapplying for the mortgage.
Another reason mortgage applications often get denied is because of a high debt-to-income ratio. This is determined by adding up all of your monthly debt payments and dividing it by your gross income -- that is, the amount that you earn before taxes are taken out. Ideally, you'll keep this ratio under 36%, but you may still be able to get a loan with a debt-to-income ratio up to 43%. If yours is higher than this, you should work on paying off your debts before you reapply.
You could also try increasing the size of your down payment. This increases your chances because you're borrowing less money and thus lessening the risk to mortgage lenders. But not everyone can afford to do this.
2. You can't afford the down payment
Conventional wisdom says you should put 20% down when buying a home. Doing this will increase your chances of approval and score you the best interest rates, plus you won't have to pay for any private mortgage insurance (PMI). But you don't have to put 20% down.
Some mortgage lenders will allow a down payment of as little as 3%. But depending on your credit history, the type of home, and your mortgage type, you could be required to pay more than this. Talk to your mortgage lender to learn more about the minimum down payment you'll be required to make.
Do the math and see if you could afford the higher monthly mortgage payments if you made a smaller down payment. If you can, you may want to consider applying for the mortgage , provided your credit is good. But keep in mind that you'll end up paying a lot more in interest over the life of the loan.
You can also see if you qualify for down payment assistance grants or interest-free loans. These programs are often run by state agencies, and you don't have to be low-income to apply. Best of all, if you qualify for a grant, you may never have to pay the money back depending on certain stipulations. It probably won't cover the full 20% down required to avoid PMI, but it can still give you enough to get approved for the loan.
If you can't afford even 3% down, you'll have to look at ways to boost your savings. Creating a budget is a good first step. Look for ways to cut unnecessary spending and put all your extra cash toward your down payment. You may also want to consider working overtime or picking up a side gig to get extra money.
3. Mortgage rates are too high
Mortgage rates are at a seven-year high, which can make it challenging to afford your monthly payments. Before you begin shopping around, you should know how much you can comfortably afford to spend on your mortgage payment. You don't want to choose anything that would strain your budget, because then you could fall behind on your payments if an unexpected expense arises.
If you're having trouble finding a mortgage that fits into your budget, it's a good idea to shop around to see what other lenders are willing to offer you. While all lenders look at the same factors, more or less, when evaluating your application, they all measure risk slightly differently; one may be willing to offer a slightly better rate than another. It's important to submit all of your mortgage applications within 45 days of one another, though. This way, your credit report will only register a single hard inquiry rather than several, which can lower your credit score.
Keep an eye on the mortgage rates even after you close on the home. When the rates begin to drop, you can refinance. Even the difference of a quarter of a percentage point could add up to tens of thousands of dollars in savings over the lifetime of your loan.
Say you bought a $200,000 home with a 30-year mortgage that has a 4.25% interest rate and 20% down. If you stuck to the original loan term, you'd pay about $283,000 in totalover 30 years. But if you decide to refinance five years later and you can get a 4% interest rate, you're now only spending about $264,000 over the life of the loan.
In many cases, refinancing will reduce your monthly payments. But you could end up having to pay closing costs again,so you'll have to do the math to decide if the amount you'd save is worth all the hassle.
If you're serious about buying a home, you can find a way to make it happen. There may not always be a quick solution, but by being responsible with your money and realistic about what you can afford, you can come up with an actionable plan to secure your dream home.