Photo by: Enokson.
Gone are the days of so-called "liar loans" -- now banks are more stringent with who they lend to.
Luckily, mortgage software company Ellie Mae gets a look into just what it takes to get a loan to buy a home. The company's September Origination Insight Report reveals some key differences between approved and denied mortgage applicants.
Approved and denied FHA borrowers
In September 2013, the average approved FHA borrower was granted a loan for 95% of the purchase price of their home with an average credit score of 694. Approved borrowers kept their mortgage payments and other related expenses to just 29% of their annual gross income. For all debts, borrowers had a debt-to-income ratio of 41%.
The average denied borrower had a credit score of 671 and also sought a loan equal to 95% of the purchase price, roughly similar to approved applicants.
However, when it came down to their ability to make payments, most denied borrowers fell flat. The average denied borrower fit within the FHA's 33% limit on housing expenses to gross income, but went well over the total debt-to-income ratio, at 47%.
What about conventional loans?
Conventional loans generally require much larger down payments and significantly better ability to repay than FHA loans. This proved to be true last month.
The average approved borrower seeking a conventional loan had a credit score of 758, and put up a 20% down payment on their purchase. Conventional borrowers were also much better credit risks for banks with a housing-related debt-to-income ratio of 23%, and a total debt-to-income ratio of 34%.
Surprisingly, those who were denied had generally good credit scores -- around 724 -- and were seeking loans equal to 81% of a home's purchase price. Denied applicants failed in the ability to repay category, showing housing-related expenses at 26% of their gross income, and total debt expenses at 42% of income.
How you can improve your approval odds
It's becoming clear that lenders are using debt-to-income ratios as their filter for good and bad applicants.
This is both good and bad news for borrowers. Those who have consumer debt -- credit cards, personal loans, or automotive balances -- can quickly improve their odds of approval by paying down their balances.
Mortgage broker Denise Panza told me that "paying installment debt to where it has 10 payments left is huge!"
Lenders do not consider installment debt payments in debt-to-income calculations if there are 10 payments or fewer remaining.
Consider this: A borrower with one year left on a car loan may have a balance as small as $2,400. However, at monthly payments of $200 per month, that small car loan balance will add significantly to a borrower's debt-to-income ratio. Making two early payments would push the balance down to the 10-month threshold, where it isn't counted in debt-to-income ratios.
Paying off small balances that require large monthly payments can result in quick and relatively painless improvements in your debt-to-income ratio -- and improve your odds at getting a mortgage.
As a bonus, borrowers who pay down credit cards would see a higher credit score as their total credit utilization drops with each payment, which could result in a lower interest rate at closing.
