Getting A Mortgage: How The Process Has Changed
In the heyday of the housing boom in 2004 and 2005, lenders used to joke that "all you need to get a mortgage is to be breathing." Times have changed. Between the real estate market debacle and the banking crisis, standards for loan approval have tightened far beyond breathing. (For related reading, take a look at 4 Key Factors That Drive The Real Estate Market.)
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While it may be harder to qualify for a mortgage today, the process in many ways is simply a return to the pre-housing boom days when consumers were required to prove their income and assets, demonstrate their ability to repay the loan and have sufficient savings for a down payment and cash reserves.
Down Payment Requirements
The days of widely available, no-down-payment loans are gone for most buyers. In the midst of the housing boom, no-down-payment loans were readily available, but these days conventional loans require a down payment of 5 to 15%. Government-insured FHA loans require a down payment of 3.5% for qualified buyers, but those with a credit score below 580 must make a down payment of 10%. VA loans, available to members of the military and veterans, are available without a down payment. The USDA loan program, available to residents in designated rural areas, also offers no down payment loans. (Learn more about VA loans in The Unique Advantages of VA Mortgages.)
Borrowers used to be able to apply for a variety of mortgage products such as interest-only loans and option-ARMs. While interest-only loans are rarely available today, the option-ARMs have disappeared completely. Plain vanilla fixed-rate loans are the most popular for the majority of borrowers today, followed by hybrid ARMs with a fixed-rate of one-to-ten years, followed by a rate that adjusts yearly. (Read more about option-ARMs in Option ARMs: American Dream or Mortgage Nightmare?)
Lenders today rely more heavily than in the past on your credit score to determine not only whether you qualify for a mortgage but also to set your interest rate. While lenders vary, most say a credit score of 680 is required to be approved for a conventional loan. FHA loan requirements are a little looser, and some lenders (but not all) will approve an FHA loan for a consumer with a credit score of 620 or under. Many require a score of 640 for an FHA loan. Borrowers with a credit score of 720 or 740 and above are likely to be approved, depending on other financial circumstances. Interest rates are set on a tiered basis, with the best interest rates going to borrowers with the highest credit scores.
At the height of the housing boom, many lenders were approving "no-income verification/no-documentation loans," but those are pretty much impossible to find today. Borrowers need to prove their income with two years of tax returns and will need bank statements to prove that they have assets and cash reserves. Money that is being used for a down payment and closing costs must have a paper trail that shows where it came from, since there are rules concerning the ability to use gift funds.
A few years ago, lenders were approving "stated income" loans, but now lenders take the time to verify employment and are looking carefully at job stability as part of the approval process. Mortgage approvals are much more difficult for self-employed applicants who must prove a steady stream of income and the viability of the business.
Another more restrictive move for borrowers today is the debt-to-income ratio. In the days of looser guidelines, lenders were more willing to stretch debt-to-income ratios to as much as 50% if the borrowers seemed to have the ability to repay the loan. Most lenders now limit borrowers to a housing payment of 31 to 33% of gross monthly income and an overall debt of 43 to 45%. Sometimes a high credit score or significant cash reserves or a high down payment will allow borrowers to exceed these guidelines, but lenders are much less willing to expand these ratios than in the past.
Extra Credit Checks
As part of their new stricter guidelines, lenders sometimes recheck your credit after a loan approval but before the loan settlement date as an added protection for their investment. Borrowers need to be very careful to avoid using their credit cards, applying for additional credit or switching jobs during the crucial period between a loan approval and the settlement.
The Bottom Line
All of these new rules and changes to the mortgage process mean that one more thing has changed since the banking crisis: Loan approvals take longer. Lenders now have to carefully check every detail on the loan application along with having an appraisal done, so borrowers need to be prepared for an application-to-settlement period of at least 30 days, but often 45 to even 60 days. While this may be frustrating, it is all part of a renewed effort among lenders to carefully screen loan applicants. (For additional reading, also check out Can You Hit A Perfect Credit Score?)