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Almost everyone will need a mortgage at some
point in their life. We’ll help you understand exactly what
a bank is looking for when they give you such a big loan.
A recent MotleyFool.com article discussed some of
the things that lenders look for in potential clients. Basically,
a lender has three questions: (1) what is your income, (2) what
is your credit history, and (3) what do you have of value. We’ll
walk through each question in turn:
Income
The basic question here is whether you have enough
money to pay the lender back, in addition to paying back your
current debts. The lender will not only look at what you make
now, but when they expect you to make over time. Lenders want
to know all the financial assets you have, such as mutual funds
or cars, and all the debts you have, such as credit cards or student
loans.
There are two nifty, but basic, formulas lenders
use to roughly calculate how much of a mortgage payment you can
handle. The first is called the front-end ratio. Essentially,
they take your gross income of, for example, $3000 a month and
take 29 percent of this. In this example, that would be $870/month.
This amount is what lenders consider you are able to pay each
month toward mortgage payments. The second calculation is called
the back-end ratio. Here, your debt is examined. Lenders do not
want other debt payments to exceed 41 percent of your gross monthly
income.
Trustworthiness
To determine whether or not you are trustworthy,
lenders will look to your credit rating. This includes such information
as whether or not you have a track record of paying your bills
on time.
The three major credit reporting agencies are Equifax,
Experian and TransUnion. For a relatively small fee, you can get
a copy of your credit rating, so that you know ahead of time whether
things look good. If they don’t, then there are things you
can start doing now to help make things look a whole lot healthier
to lenders.
Collateral
This is essentially the worst case scenario. Banks
want to make sure that you have enough assets to pay back the
loan if ever you stop being able to make your monthly payments.
However, in the majority of cases, your new home is usually what
a bank will use as collateral. This means that banks have the
right to foreclose on the mortgage and repossess your house if
ever you stop being able to make your monthly payments. They then
have ownership of the house and will sell it quickly in order
to get their principal loan balance back. This usually means the
house gets sold for less than it is really worth, and you’ll
be lucky to even get your down payment back. Avoid this scenario
at all costs. Other than being a financially bad result, it also
means that people are a lot less likely to ever lend to you again.
By understanding exactly what it is that lenders
are looking for, you can understand why you were qualified for
the amount of loan you were, and you can start putting yourself
in financial shape right away.
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