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by Daniel B. Kline
December 05, 2017
by Daniel B. Kline
December 05, 2017
While television commercials can make it seem like getting a mortgage requires just a few clicks of a button, that's rarely the case in reality. For most people, securing a loan to buy a home takes time, and means intense scrutiny from the institution doing the lending.
It's not an overly pleasant project -- getting approved for a loan involves having you full financial picture scrutinized. The bank or another lending source will look at your income, your savings, your debt, and your bill-paying history.
There's generally no way around that if you need a mortgage, but preparation can make the process go more smoothly. If you plan to apply for a loan, do these things first and you can increase your chances while also making things easier for yourself.
Most lenders use FICO credit scores, issued by the Fair Isaac Corporation. Scores, which range from 300-850, come from data provided by the three major credit bureaus -- Experian, Equifax, and TransUnion. You essentially have three credit scores, but in many cases, mortgage lenders will use the lowest one to rate your credit worthiness.
How these scores are interpreted can vary, but Experian defines 300-579 as "very poor," 580-669 as "fair," 670-739, as "good", and 740-799 as "very good." Anything above 800 is considered exceptional.
Your credit score will be a major determining factor in whether you get a loan. With a lower score, you may still get approved, but you will pay a higher rate.
One way to immediately improve your credit score is to pay off any existing credit card balances. Your credit score consists of payment history (35%), credit utilization (30%), average credit age (15%), new inquiries (10%), and account mix (10%). Of all of those, the only one you can really control in the short-term is credit utilization.
Paying off your credit cards can lead to a significant jump in your score. It also looks good to the bank or lending institution reviewing your overall financial picture.
There are two ratios your lender will use to determine how much it's willing to loan you.
In most cases, mortgage lenders will let you spend 30% of your gross income toward your loan payment. That means If you make $4,000 a month, you will be able to afford a $1,200 monthly payment.
The second factor is your total debt picture, including the potential mortgage. This includes car loans, credit card debt, and any other money you owe. In a broad sense, lenders won't want this number to be higher than 40% of your income. These numbers are not absolutes, but they give you a strong idea of how much you can afford.
Mortgage lenders require a lot of paperwork. In most cases, you will need your past two years of taxes, at least two months of bank statements, and documentation for any retirement accounts. You will also need your two most recent pay stubs, as well as documentation for any non-work income.
Buying a car, a boat, or some other big purchase can lower your credit score and increase your debt. Don't even consider buying anything big until after your mortgage closes. Your lender will monitor your credit throughout the process, so don't think that getting an approval means you are home free.
The rules about down payments vary depending on where you live. In Florida, for example, buying a condo nearly always requires that you put 20% down. Obviously having to do that means you need more cash upfront, so it's important to be aware.
In some cases, houses are different than condos, and in many cases where you intend to buy matters. These factors may change how much you want to spend, and in some cases how much you can spend, so it's important to understand your specific housing market before you get started.
Just because you can get approved for a certain level of mortgage does not mean you have to spend that much. Do an honest appraisal and decide how comfortable you will be with debt.
Some people are OK being a little poor for a while if the down payment plus the mortgage payments causes a notable change in expendable income. Others would rather have less house to minimize that.
Understand which type of person you are before starting the loan process. That's important because borrowing less than you could qualify for may come with lower rates.