Getting approved for a loan in recent years can be a very frustrating experience. Just when you think you are all done, there is another round of items needed. If there is a bright side, things have gotten better in the last few years. There are more loan options currently available than at any time in the past decade. Lenders have started to slightly expand their lending guidelines with more loan products slated to hit the market.
The one constant in the industry are the three pillars of loan approval. When you strip everything else away these three items determine your approval, your interest rate and many of the terms you are eligible for. Here are the three main items needed for any loan approval.
Credit Score. The starting point for any loan application is a breakdown of your credit report. The most important item on your report is the score. The three main bureaus (Equifax, Transunion & Experian) give a numeric score ranging from 450-850, with the higher the score the better. Your score is based on a handful of components including timeliness of payments, available credit per account, new credit history and recent credit pulls. The floor with some lenders is a 580, but most around a 620. The higher your score the more options you have and the lower down payment you can get away with. On the flip side, with a low score your options will be limited, or you will be required to put a significant amount down. If you haven’t looked at your credit report in some time it is a good idea to take a look. Removing just one old account can boost your score 30-40 points.
Down Payment/Equity. One of the biggest changes in recent years is the addition of more reduced down payment loan programs. If you wanted to buy a house right after the mortgage collapse you needed at least 10% down, and in some cases much more. As the market stabilized guidelines have loosened, especially regarding down payment. Today, there are programs that allow for just 1% down with an excellent credit score and other compensating factors. The minimum for an FHA loan product is 3.5% and some conventional loans 3%. Depending on the program these funds may have to be in your account for at least 60 days or it could be 100% gifted. The stronger your credit score and overall loan profile the more down payment flexibility you will have.
Debt/Income. It is not enough to make a strong income. If your debt is too high, it may not make a difference. The final pillar of loan approval is something called your debt to income ratio. Simply put, the lender adds all the minimum monthly payments on your credit report plus the total proposed monthly payment. They divide this number by your gross monthly income and if that number typically exceeds 50% your loan will be rejected. This sounds like a complicated formula, but it is the standard for which every lender evaluates debt. There are some items that are thrown out such as deferred student loan payments and items with less than five payments remaining but everything else on the report is factored in.
On one hand loan approval is pretty cut and dry. On the other it can be quite complicated with numerous items required. If you are looking to buy a house start by evaluating how strong you are in these three areas. Look at your credit report, determine how much money you have for the down payment plus closing costs and find your last paystub or tax return. If you are strong in these three areas everything else should fall in line.