Anyone who has applied for a home mortgage loan recently knows how elusive the best interest rates, loan terms and ultimate mortgage loan approval can be. The good news is that steps can be taken to vastly improve the odds.
This is not your father’s loan environment but may bear some resemblance to your grandfather’s. Before the terms subprime mortgage, real estate bubble, and short sale were even a glimmer in the eye of Wall Street mortgage securitization moguls, old school bankers sat at their old school desks and approved or denied mortgage loans based on old school standards. Our grandparents wouldn’t have even considered asking the local banker for a loan without first “putting on their Sunday best.”
Hopeful homebuyers vying for a mortgage loan in today’s environment are well served to do the equivalent. But modern-day loan decision-makers seldom meet the borrowers whose homeownership destinies lie in their hands. This necessitates looking polished on paper and thinking of a loan application as a financial resume. The application is where loan underwriters garner their first impressions about borrowers, and if those impressions are not good, it’s game over.
Appiications for home purchase rose 2.6% in the Mortgage Bankers Association's most recent weekly survey, but that's up from a 6-month low.
So what does it take for a mortgage borrower to look polished on paper? The answers are simple, though achieving them often takes time:
- A good credit score – preferably 720 or higher
- A big down payment – ideally as close to 20% as possible
- A low debt-to-income ratio (DTI). A best case scenario comes close to 30% on the front end -- income compared to housing debt cost -- and 40% on the back end -- income compared to all debt costs).
While loans are certainly available at lower thresholds, a high credit score, big down payment and low DTI translate into the very best loan terms, including the lowest available interest rate, and tens of thousands of dollars in savings over the life of a loan. Borrowers with hefty assets generally have more leeway skimping on the credit score, down payment and DTI than those who don’t.
The problem is, average credit scores today are 40 points or more less than optimal, which means most borrowers need to find time to write to credit bureaus, pay down balances and improve scores before applying for a mortgage.
Twenty-five percent of renters today spend over 50% of their income on rent, and down payments, which not long ago averaged 3.1% of income, now average a whopping 7.5%. That means many need to cut back on spending or take on a second job to save for a down payment before homeownership is even considered.
In addition, student debt is driving up debt-to-income ratios for many first-time buyers, creating the biggest challenge. For these and other reasons, many borrowers need six months or more to polish themselves up on paper, which makes planning ahead key.
Don't be shy: The home loan process is no place for shy folks. Getting the best deal requires asking questions, shopping for service providers and negotiating because mortgage loan closing costs are up 6% since 2012. The good news is some of those costs are negotiable, but only for folks who take the time and muster up the gumption to ask. Again, it's time well spent, which can translate to hundred of dollars in savings.
Creativity can also pay off in spades. For example, as interest rates rise, expect to see more homebuyers asking sellers to kick in some cash to help buy down the loan’s interest rate. And conservativeness is always a good trait when it comes to home loans. There’s no rule that says homebuyers have to spend the full amount a bank issues a loan approval for. Spending less leaves more cash available for saving, emergencies or just plain old fun. A home is a financial stepping stone, not necessarily a dream home, particularly for first-time buyers.
Features, such as square footage or property condition, are often fixable over time. And understanding the actual cost to carry that extra bedroom or super-sized yard may lead many a buyer to re-evaluate home-shopping priorities.
Condominiums and townhouses can also be a great alternative for buyers determined to live in a neighborhood that might not otherwise be affordable and they often provide more predictability when it comes to maintenance.
The mortgage loan application process certainly has its fair share of uncontrollable moving parts. All the more reason for borrowers to take the proverbial bull by the horns wherever the opportunity to do so arises.
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