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Mortgage rates are near record lows right now, making it a great time to apply for a home loan. However, while it may be more affordable to get a mortgage now than at any time in recent history, it's also become increasingly difficult to actually get approved for one.
Many lenders have tightened credit standards as a result of economic uncertainty caused by COVID-19. Unfortunately, that's making it harder for some people to take advantage of today's unprecedented bargains on fixed-rate mortgages.
If you're considering applying for a loan, it's important to be aware of four possible red flags for lenders that might prevent you from getting the mortgage you're hoping for.
1. Your employment situation isn't stable
Lenders want to know you're going to be able to repay your mortgage loan. And the best way they can determine that is to look at your earnings history. Specifically, mortgage loan providers will want to see that you've worked for the same employer for at least a few years, and that your income has remained largely the same (or gone up a bit over time).
If you just got a job two months ago, if you've changed employers five times in the past six months, or if your income is all over the place, this is going to be a big red flag to lenders that could ultimately lead to a loan denial.
Lenders will ask for past tax returns and pay stubs to assess whether your income is likely to remain steady over time so you can pay back your loan. They may also want proof from your current employer that you actually do have a job with them. If you can't provide proof of stable earnings and current employment, you can likely kiss your chances of getting a mortgage goodbye.
2. Your income is too low
Lenders want to see stable income, and they also want to make sure your income is high enough to easily cover the bills. Specifically, they'll look at your debt-to-income ratio (DTI), which is the amount you owe relative to earnings.
There are actually two different DTI ratios that matter when it comes to determining if you can get a home loan. The "front-end" ratio compares your total housing costs (including mortgage payments, taxes, and insurance) to your income. Ideally, your housing expenses should come in at less than 28% of income. The "back-end" ratio compares total debt, including mortgage cost and other bills, to income. That ratio should ideally be below 43%.
If you aren't making very much money and your debt-to-income ratio is too high, lenders are going to be very unlikely to approve you for a home loan.
3. Your credit score isn't good
It's not just your income that lenders use to predict the likelihood you'll pay your loan balance -- they'll also look at your past track record of paying your bills. The easiest way for them to assess whether you've been responsible with your debt is to look at your credit score and report.
If your credit score is too low and your report shows a track record of defaults, missed payments, or a recent bankruptcy or foreclosure, lenders are going to be concerned that you won't pay them on time. As a result, you'll probably get denied for a loan.
While some government-backed mortgages, such as FHA loans, allow you to borrow with a credit score as low as 500 (with a 10% down payment), you will have a hard time getting a loan from a conventional lender without a score of at least 620. And if your score isn't in the mid to high 700s or above, you're going to pay more in interest if you are approved for a home loan.
4. Your down payment is too small
Finally, lenders want you to have some skin in the game. Specifically, they want to make sure you're contributing a down payment. This means you're putting your own money on the line, and it reduces your loan-to-value ratio (which is determined by the amount you're borrowing relative to the market value of the home).
In general, if you borrow more than 80% of the value of your home, lenders are going to charge private mortgage insurance (PMI) to protect themselves from losses. Otherwise, it could be hard for them to sell your home for enough to pay off the loan and all costs if you default. If you've made a 20% down payment, though, there should be plenty of equity in the home, and lenders should have no trouble getting their money back if they must foreclose.
While lenders generally require PMI, most won't deny you a loan if you have less than 20% down. In fact, it's possible to get some home loans with just a 3% or 3.5% down payment (or with no down payment at all for certain government-backed mortgages). Still, if you want to put either very little or no money down, many lenders won't be willing to give you a loan for 100% of your new home's value -- especially if your credit and other financial credentials are imperfect.
So even though mortgage rates are low right now, if you're having trouble getting approved for a loan -- or fear that you might run into problems -- consider these four points before you jump into the market. You may be able to make a few changes to help set yourself up for the best possible outcome. And at the very least, you'll know what to expect and can look for a lender that may be willing to work with you despite the challenges.
