Mortgage qualifying is the process of determining how much a borrower can afford to borrow and repay for a home loan. There are three basic pillars pertaining to your personal finances that lenders use to evaluate the borrower’s eligibility: affordability, collateral, and creditworthiness.
1.) Affordability: This is the measure of how much the borrower can pay each month for the mortgage, based on their income and expenses. Lenders use different ratios to calculate affordability, such as the debt-to-income ratio (DTI) and the housing expense ratio (HER). These ratios compare the borrower’s monthly debt payments and housing costs to their gross monthly income. Several factors impact what constitutes qualifying income1,2. Various loan programs have different ratio requirements which may impact the type of loan you qualify for.2.) Collateral: This is the value of the property that the borrower wants to buy or refinance with the mortgage. The value of the property is determined by an independent appraiser3. Lenders use collateral to secure the loan and reduce their risk of loss in case of default. The borrower needs to provide a down payment4, which is a percentage of the property’s purchase price, and closing costs5, which are fees and charges associated with the loan transaction. The down payment affects the loan-to-value ratio (LTV), which is the percentage of the property’s value that is financed by the loan. Depending on the loan amount, borrowers can put as little as 3% down and finance the remainder of the purchase price. These loans may be subject to private mortgage insurance6. Further, interest rate adjustments may be applicable in the case of a lower down payment or higher loan to value.
3.) Creditworthiness: This is the assessment of how likely the borrower is to repay the loan on time and in full, based on their credit history and score. Lenders use credit reports from major credit bureaus, such as Equifax, Experian, and TransUnion, to check the borrower’s past and current credit accounts, payment history, balances, and inquiries. They also use credit scores7, which are numerical ratings that summarize the borrower’s credit risk, based on different factors such as payment history, amounts owed, length of credit history, types of credit used, and new credit. Even in the case of major credit challenges, opportunities for mortgage qualification still exist8. Creditworthiness can impact the type of loan a borrower qualifies for and may impact the interest rate that is charged.
A fourth pillar exists which involves the home being purchased. Not only is condition an important element, but the property type9 can impact financing options, i.e., single family home, condominium, townhouse (PUD) etc.
All these three pillars combine to determine how much the borrower can qualify for and what type of loan they can obtain. Different types of loans have different eligibility requirements, interest rates, terms, and features. For example, conventional loans10 are loans that are not insured or guaranteed by the federal government, and they typically have stricter eligibility criteria than government-backed loans, such as FHA loans11 and VA loans12. The borrower should compare different loan options and choose the one that best suits their needs and goals.
Working with an experienced professional who is well versed in all these programs and options is critical to obtaining the most desirable outcome. Further, strategic use of various programs and pricing options13 can save you thousands of dollars over the duration of your home ownership. Reach out with any questions about your situation or clarifications on any of this content.
Footnotes:
1. See Mortgage 201 Self-employed and Retired borrowers.
2. See Mortgage 202 Commission and Bonus Income and Recent Job Changes
3. See Appraisal: What is it and how is it Calculated?
4. See Down Payment
5. See Closing Costs
6. See What Is Private Mortgage Insurance? Do I need it and how do I get rid of it?
7. See Credit: Scores and More
8. See Major Credit Events
9. See Property Type and Occupancy and the Impact on Financing.
10. See Conventional Loans: What is Fannie Mae and Freddie Mac?
11. See FHA Loan Basics
12. See VA Loan Basics
