Banks' willy-nilly lending practices a decade ago led to the worst financial crisis since the Great Depression, so it's understandable that mortgage lenders are a bit gun-shy when it comes to lending money for home purchases.
Although mortgage lenders are far more cautious with their money nowadays, following these three steps can improve your odds of landing a loan to buy your dream home.
Step 1: Check your credit score
If you want the best shot at getting mortgage lenders to approve your loan, don't walk in until after you've scrutinized your credit report and taken steps to boost your credit score.
There's no faster way to get mortgage lenders to say no than showing up at their office with a credit score that's not up to par. Request a free copy of your credit report and make sure there aren't any errors, such as missing payments or fraudulent accounts. If there are, contact the creditor and the credit bureau to get them fixed.
Once you've done that, take a hard look at your credit score. You can get that score online through various services, but personally, I'm a fan of Credit Karma -- an ad-based website that provides your score (and valuable credit score tips) for free.
If your score is north of 750, you'll probably have your pick of mortgage lenders, and you'll also likely get offered the best interest rates and down-payment terms. If your score is less than 700, you may find it more difficult to obtain approval, and you may need to pay a higher interest rate and put more money down to get a green light.
Because lower credit scores can reduce your chances for a thumbs-up and can result in higher costs, it may be worth delaying your mortgage loan application until your score improves.
To make sure that your credit score improves quickly, take the following action:
- Get current on all your debt, including auto loans and credit cards -- and stay current.
- Pay down credit cards so that you're utilizing less than 30% of your available credit line.
- Minimize hard inquiries on your credit report by waiting to apply for a new credit card or car loan until after you've obtained your mortgage loan.
Step 2: Think small
The pricier a home, the less likely mortgage lenders will be to approve your mortgage application. Typically, mortgage lenders don't want to see your mortgage, property taxes, and home insurance payments eclipse 28% of your gross monthly income.
Although a bank may be willing to go up to 28%, you may be better off thinking smaller. In the Great Recession, many homebuyers were caught short when jobs and savings vanished, leading homeowners to be foreclosed on and declare bankruptcy.
Avoid that potential future risk by thinking conservatively. Instead of shopping for a home that's at the top end of your 28% range, consider buying a smaller home or a home that may need some TLC.
Step 3: Pay down that debt
Once you have your credit score where you need it to be and you've picked a realistic price range for your new home, you'll also need to make sure your future monthly debt payments won't raise mortgage lenders' eyebrows.
First, add up all your monthly payments on credit cards, student loans, and car loans. Then add to that figure the expected monthly costs associated with your mortgage, property taxes, and insurance. Once you've done that, divide that total by your monthly income to get your debt-to-income ratio. If your debt-to-income ratio is less than 36%, then mortgage lenders will likely applaud. However, if you're above 36%, you may need to pay off some of your debt to lower your monthly payments, or go back to the drawing board and find an even less expensive home to buy.
Ducks in a row
In order to guarantee mortgage lenders will fight to win your business, do your prep work ahead of time so that you (and your lender) won't end up disappointed. Although these three steps won't guarantee you an approval, they should help get you closer to hearing those exciting words, "You're approved!"