Being able to buy a home usually depends on being able to borrow.
Lenders evaluate, or underwrite, your mortgage application to decide if you’re a good risk. In general, what they want to see is:
• A down payment, or initial cash payment, of 20% or more of the purchase price
• No more than 28% of your gross annual income needed to pay PITI—principal, interest, homeowners insurance, and property taxes
• A strong credit report, without late payments or defaults
• A debt-to-income (DTI) ratio of no more than 43%, which means that you need no more than 43% of your gross annual income to pay your mortgage plus your other debts
• A history of regular employment at a full-time job
Meeting Lender Standards
You may hear the criteria that lenders use in evaluating your application for a mortgage loan described as the big three.
Capacity addresses your ability to have enough cash for the down payment and closing costs, keep up with the loan payments, and still have some assets in reserve. In general, capacity depends on your current monthly income, your investment assets, and your other financial obligations.
Collateral is the value of the property that you plan to buy. A lender requires that it be worth at least as much as you’re borrowing to buy it. To make that judgment, the lender hires a professional appraiser to evaluate the property both on its own merits and in relation to comparable properties.
Creditworthiness depends on how you have used credit in the past, including loans and lines of credit. Lenders use both a credit report and a credit score based on the report to make this assessment.
Some lenders may use information on your rent and utility payments and other contractual spending to evaluate the risk you pose. This is known as alternative documentation. They may also use automated underwriting systems, which are software programs that use statistics from comparable purchases by comparable buyers to provide an objective measurement of the risk of approving your application.
Other Routes to Ownership
There are other ways to buy. You may want to investigate a rent-to-own arrangement or consider buying at auction.
When you rent-to-own, you sign a contract with the owner that gives you an option to buy, with some or all of your lease payments being credited toward the agreedupon sale price. There are potentially some drawbacks, though, including the possibility the sellers will change their minds if real estate prices go up, so be sure to have an experienced local real estate lawyer review the contract before you sign.
Auctions, where you can buy homes that have been repossessed or are being sold to settle an estate, can help you find a great house at a great price. But there are serious risks for inexperienced buyers. Unless you’re serious about becoming an auction expert, you may do better looking for short sales—homes that are being sold below value so that the sellers can pay off their loans at a price their lenders have agreed to accept.
If You're Turned Down
If your application is turned down, there are a number of steps you can take.
• You might apply to a different lender, as loan criteria vary among lenders
• You might look for a less expensive home that will still meet your needs
• You might work with a mortgage broker to find a lender, though there will be a fee
The Consumer Financial Protection Bureau (CFPB), acting on the changes mandated by Congress in the Dodd-Frank Act, prohibits qualified mortgages from including negative amortization provisions, interest-only payments, balloon payments, terms longer than 30 years, or points and fees in excess of 3% of the loan amount—though third-party costs, including title insurance, taxes, and filing fees are exempt from the 3% rule. Negative amortization occurs when interest you haven’t paid is added to your outstanding principal. There are exceptions, including those for mortgages in rural areas. And different rules apply to subprime loans, which have higher-than-market APRs. But if you have questions about the terms of a mortgage you’re offered, consult your lawyer and contact the CFPB at www.consumerfinance.gov.
The Waiting Game
Within three days of applying for a mortgage loan you should be mailed a good faith estimate (GFE) of what the closing, or settlement, fees will cost you if you use that lender. In addition, you’ll receive a Truth in Lending (TIL) form that states the APR and other details about your costs. You may want to apply to two or perhaps three lenders and use the GFE and TIL forms they provide to compare the offers and potentially negotiate a lower rate or lower fees. Remember, though, that these numbers are estimates, and they could change somewhat by the actual closing.
It can take up to 30 days after you’ve submitted a completed application to get an answer from a lender, though the wait may be shorter. If you’re approved, you’ll get a written commitment letter stating the terms of the loan agreement and how long you have to set a closing date. If your application is successful, you should try to lock in the interest rate that’s available at the time it’s approved, with the understanding that if rates drop you’ll actually finalize the purchase at the lower rate. Some lenders charge a fee for a lock-in, which you can ask about when you do your initial research.