Getting approved for a mortgage can be tough, especially if you've been turned before. In this article, we outline six steps that you can take to help you get approved for a mortgage and become a homeowner.
Go to any mortgage lending website, and you'll see images of smiling families and beautiful homes accompanied by text that makes it sound like lenders are standing by just waiting to help you find the loan that works for you no matter what your situation.
In reality, lending such large amounts of money is a risky business for banks. In other words, banks aren't going to lend you hundreds of thousands of dollars unless they're confident you can pay them back and on time.
If your dream of owning a home has been dashed by loan officers denying your application, you can take steps to get back on the path to homeownership.
Get a Cosigner
If your income isn't high enough to qualify for the loan your applying for, a cosigner can help. A cosigner helps you because their income will be included in the affordability calculations. Even if the person isn't living with you and is only helping you make the monthly payments, a cosigner's income will be considered by the bank. Of course, the key factor is to ensure that your cosigner has a good employment history, stable income, a good credit history.
In some cases, a cosigner may also be able to compensate for your less-than-perfect credit. Overall, the cosigner is guaranteeing the lender that your mortgage payments will be paid.
It's important that both you and the cosigner understand the financial and legal obligations that come with cosigning a mortgage loan. If you default—fail to make payments—on your mortgage, the lender can go after your cosigner for the full amount of the debt. Also, if payments are late or you default, both your credit score and your cosigner's will suffer. A credit score is a numerical representation of a borrower's credit history, creditworthiness, and ability to pay back a debt.
Of course, you shouldn't use a cosigner to get approved if you don't make enough income to pay the mortgage on time. However, if your income is stable and you have a solid employment history, but you still don't make enough for a mortgage, a cosigner can help.
Sometimes conditions in the economy, the housing market, or the lending business make lenders stingy when approving loans. If you were applying for a mortgage in 2006, banks were offering no-income verification loans. However, those days are long gone. Today, banks are scrutinized by regulators and the Federal Reserve Bank to ensure that they're not taking on more risk than they can handle. If the economy doesn't support a robust housing market where banks are actively lending, perhaps it's best to wait until the market improves.
While you're waiting, home prices or interest rates could fall. Either of these changes could also improve your mortgage eligibility. On a $290,000 loan, for example, a rate drop from 7% to 6.5% will decrease your monthly payment by about $100. That may be the slight boost you need to afford the monthly payments and qualify for the loan.
Work on Boosting Your Credit Score
You can work on improving your credit score, reducing your debt, and increasing your savings. Of course, you need to first obtain your credit score and get a copy of your credit report. The Consumer Financial Protection Bureau, which is a government agency, has helpful information on their website to obtain a free credit report. The report will list your credit history, your open loans, and credit card accounts, as well as your track record for making timely payments. Once you have the report, you'll be able to obtain your credit score from one of the three credit agencies for free.
Build your Credit History
If you don't have a lot of credit history, it can hurt your chances of getting approved for a mortgage. Consider opening a secured credit card with a small credit limit. Secured cards require you to have an amount of cash saved with the credit card company that matches the card's available credit. A secured card eliminates the credit card company's risk, which improves your chances of getting approved. Also, a secured credit card is a great way to build your credit history and show banks that you can borrow from a card and pay off the balance each month. However, if you have too many cards open, opening another one may hurt your credit score.
Manage your Credit Cards
Making on-time payments is critical to boosting your score. Also, pay off some of your debt so that your card balances are not close to the card's credit limit—called credit utilization. Credit utilization is a ratio reflecting the percentage of a borrower’s available credit that's being utilized. If a card has a limit of $5,000 and a balance owed of $2,500, the credit utilization ratio is 50%. On the other hand, if the card had a $4,000 balance, the ratio is 80% or ($4,000 (balance owed) /$5,000 (limit)). In other words, 80% of the card's available credit has been used up. Ideally, the lower the percentage, the better, but many banks like to see at least a 50% or lower utilization ratio.
If banks see that you're close to maxing out your cards, they'll view you as a credit risk. For example, if you can't make timely payments or reduce a credit card with a $3,000 balance over time, banks are unlikely to believe you can pay back a $200,000 mortgage loan.
Calculate your Debt-to-Income Ratio
Banks love to analyze your total monthly household debt as it relates to your monthly income—called the debt-to-income ratio. First, total your monthly gross income (before taxes are taken out). Next, total your monthly debt payments, which include a car loan, credit cards, charge cards, and student loans. You'll divide your total monthly bills by your gross monthly income.
If, for example, your debt payments total to $2,000 per month and your gross income is $5,000 per month, your debt-to-income ratio is 40% or (($,2000 debt / $5,000 income) x 100 to make it a percentage ).
Ideally, banks like to see a 40% debt-to-income ratio. As a result, it's best that you calculate your ratio and, if necessary, adjust your spending, pay down debt, or increase your income to bring down your ratio.
Set Your Sights on a Less-Expensive Property
If you can't qualify for the amount of mortgage you want and you aren't willing to wait, you can opt for a condo or townhouse instead of a house—which might be less costly. Also, opting for a smaller home with fewer bedrooms, bathrooms, or less square footage as well as considering a more distant neighborhood may provide you with more affordable options. If necessary, you could even move to a different part of the country where the cost of homeownership is lower. When your financial situation improves over time, you might be able to trade up to your ideal property, neighborhood, or city.
Ask the Lender for an Exception
Believe it or not, it is possible to ask the lender to send your file to someone else within the company for a second opinion on a rejected loan application. In asking for an exception, you'll need to have a very good reason, and you'll need to write a carefully worded letter defending your case.
If you have a one-time event, such as a charged-off account, impacting your credit, explain why the incident was a one-time event and that it will never occur again. A one-time event could be due to unexpected medical expenses, natural disaster, divorce, or a death in the family. The blemish on your record will actually need to have been a one-time event. Also, you'll need to be able to back your story up with an otherwise solid credit history.
Consider Other Lenders and FHA Loans
Banks don't all have the same credit requirement for a mortgage. A large bank that doesn't underwrite many mortgage loans will likely operate differently than a mortgage company that specializes in home loans. Local banks and community banks are also a great option. The key is to ask a lot of questions regarding their requirements, and from there, you can assess which financial institution is right for you. Just remember, banks can't discourage you from applying (it's illegal for them to do so).
In other words, sometimes one lender may say no while another may say yes. However, if every lender rejects you for the same reason, you'll know that it's not the lender and you'll need to correct the problem.
Some banks have programs for low-to-moderate-income borrowers, and they could be part of the FHA loan program. An FHA loan is a mortgage insured by the Federal Housing Administration (FHA), which means the FHA reduces the risk for banks to issue mortgage loans. You'll have to find a local bank that's an FHA-approved lender. The advantages of FHA loans is that they require lower down payments and credit scores than most traditional mortgage loans.
The Bottom Line
If you've been turned down for a mortgage, be sure to ask the lender how you can make yourself a more attractive loan candidate. With time, patience, hard work, and a little luck, you should be able to turn the situation around and become a residential property owner.