How Do Lenders Qualify Borrowers for a Mortgage ?

By Dian Hymer

Lenders look at three basic factors before they will approve you for a mortgage. First they look at your ability to repay the mortgage. This involves analyzing the sources and stability of your income as well as the amount of debt you've acquired. Second, lenders examine your credit record to determine your willingness to repay debt. A credit report that's littered with late charges is a red flag that the borrower might not be a good credit risk. Finally, the lender looks at the property that will be the security for the mortgage to make sure that the property appraises and that the seller can deliver clear title to the property.

Your repayment ability determines what size mortgage a lender will give you. A borrower with high income and low debt will qualify for a larger mortgage than a borrower with high income and high debt. Debt reduces your borrowing power.

Lenders use two ratios when they qualify borrowers for loans. Both ratios express your expenses as a percentage of your income. The first ratio is the ratio of your anticipated monthly housing expense to your gross monthly income. The housing expense is made up of the principal and interest payment on the mortgage, property taxes and insurance. This is called PITI and it's prorated on a monthly basis. Your gross income is your monthly income before deductions are made to pay income taxes.

Most conventional lenders--that is, lenders whose loans aren't federally insured--don't want the borrower's PITI to exceed 28 to 33 percent of the borrower's gross monthly income. Borrowers with a low cash down, say 10 percent of the purchase price, are usually qualified at the lower ratio, or 28 percent. With a larger cash down payment, lenders will usually allow a higher expense-to-income ratio. So if your anticipated PITI is $1,700 and your gross monthly income is $6,500, divide $1,700 by $6,500 to arrive at a ratio of 26 percent. This ratio is lower than the minimum required, so your loan would be approved, if all other aspects of your application, like the credit report, are acceptable.

The second ratio lenders use is the ratio of a borrowers total monthly debt (including their housing expense) to their gross monthly income. Lenders usually don't want this ratio to exceed 33 to 38 percent. To calculate this ratio, add your current monthly debt obligations, like car loans, to the PITI, and then divide this number by your gross monthly income.

First Time Tip: A high debt load can curtail your ability to qualify for the size mortgage you may need to buy the home you want. One way to increase your purchasing power is to pay down your debt before you attempt to qualify for a mortgage. Another way is to consolidate your debt into one lower interest rate loan. This may make a big difference if you have high outstanding balances on several credit card accounts that each charge 18 percent interest.

Yet another option, if your expense-to-income ratios are high, is to talk to a portfolio lender. Since portfolio lenders don't package their loans for resale on the secondary money market, they can be more flexible about approving mortgages.

Mortgage qualification also depends on the amount of cash you have available for a down payment (usually 5 to 25 percent of the purchase) and closing costs.

The Closing: The amount of closing costs varies depending on where you live and on what kind of mortgage you apply for, but they can run as high as 5 percent of the purchase price.