What You Need to Know Before Applying For a Mortgage
For the first-time homebuyer, the entire process of finding a suitable property, applying for a mortgage, and finally closing can be a daunting task. Mortgages, in particular, are a particularly intimidating concept to most first-time borrowers, yet it’s an absolutely crucial step in the process. While most people understand the basics of a mortgage, it’s among the most poorly understood aspects of buying a home, particularly the criteria that lenders use to determine your eligibility. Before applying for a mortgage, there are a few essential things you need to be aware of in order to make sure you’re getting a good deal and not setting yourself up for future headaches.
Your Credit Score:
We place a high degree of importance on having good credit, because for most investors, doing what we do is nearly impossible without it. As an individual borrower, having good credit is doubly important when applying for a mortgage, and you need to be aware of what yours is from the get-go. Our philosophy is that if you don’t know your credit score, don’t even bother applying for a mortgage. For one, you need to know if your score even makes you eligible for a good interest rate. You’ll want to have a clear, unambiguous picture of where you stand, and that means knowing what each of your three credit scores are, especially your middle score. Out of the three credit scores that represent your personal credit history based on credit reports from Transunion, Experian and Equifax, the score that mortgage lenders commonly use is the one in the middle, or the median of the three. This is important because while you may have a good Transunion score of 750, if you have a 680 with Equifax and another 700 with Experian, 700 becomes your median, or relevant, score. This middle score is sometimes called the “representative” credit score, and this is the most commonly used credit score used by mortgage lenders to determine your eligibility. Additionally, you should consider how many trade lines you have, your debt-to-limit ratios, and minimum payments, because all three can affect or limit your ability to get a loan. Keep in mind that as an individual buyer, your credit score is a great deal more important than, say, that of an investment trust or investment firm. For the investment firm, they’re able to access financing by proving that they can service the debt; as an individual, your credit score is the proof creditors need that you’re a low-risk borrower.
APR:
APR is the annual percentage rate, or the annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan. This is what you need to pay attention to, because to be perfectly honest most interest rates quoted and advertised may not have much meaning in practical application. In other words, the important thing to remember when comparing loan deals is the APR because it includes points and other fees. You’ll want to use this number to shop for the best deals.
Rate Lock:
Because interest rates are low and only likely to continue to rise, it’s very important for borrowers to lock in rates. You need to know how long you can lock your rate, and how much it will cost to extend that lock. This is especially important if you plan to own a home for an extended amount of time. This should go without saying, but you’ll want to get written confirmation of the lock, as some lenders will gamble and hope they can make more money by letting rates float, and be sure to keep track of the countdown so you don’t run out of time and get penalized.
Debt-to-Income Ratio:
Debt-to-income ratio is the ratio between your overall debt and annual income (both past and projected), and for obvious reasons, the higher it is, the more difficult it will be for you to secure a good deal on a mortgage. It’s a critical number that lenders prioritize when it comes to determining whether or not you qualify for a mortgage loan and how much you can qualify for. You’ll want to know your DTI, what you can do to lower it, and what to avoid that may make you an undesirable candidate for a loan. As we’ve [link:] discussed before, avoid taking out new credit, beware of zero interest or no payment credit accounts and student loans which may actually be counted against you, and know how you can pay down installment loans to increase how much real estate you qualify to buy.
LTV:
LTV, or loan-to-value ratio is used by lenders to express the ratio of a loan to the value of an asset purchased, and often plays a big role in financing. Much like DTI’s, higher LTVs can mean higher APRs, and vice versa. LTV can also determine whether or not you’ll be obligated to pay extra mortgage insurance. Be especially vigilant if you’re trying to creatively structure real estate deals and watch out for CLTV limitations (Combined Loan To Value), which encompasses the total of all loans on the property compared to the value as opposed to just the loan you’re applying for.
Reserves:
Your reserves are basically the amount of cash you have in the bank available to cover emergencies, and this is in addition to the cash required to cover the costs of closing. This might include two months of PITI (Principal, Insurance, Taxes, and Insurance), or it could be as much as six months per property owned and mortgaged. You’ll need to provide bank statements to prove this, so you’ll want to know how many months’ worth you’ll need to provide.
Collections & Charge-Offs:
Finally, do you have any collections or charge-offs showing up on your credit report? Some lenders and loan programs will require any amounts to be paid off or at least paid down, and some may not even consider you at all if either one shows up on your credit report. Obviously this depends on the program, how much you plan to borrow, and how much these amounts are or how recent they are, but regardless, don’t assume anything and always ask your mortgage loan officer to check twice because this can affect or change multiple elements of your loan offer. It can change the amount needed to close, how much you’ll get at closing, or how much you need to prove you’ve got in the bank. Again, don’t assume, and always double check. Something as simple as a forgotten phone bill from five years ago can vastly undermine your efforts in this case.
Remember, all of this revolves around your credit report and your legitimacy as a potential borrower. If you’re asking a lender to take a risk on you, the more you can demonstrate that you’re a low-risk borrower, the better your chances of securing a good deal on your mortgage, which can save you thousands of dollars over the course of the loan. Buying a home is an investment in yourself and in your future, and as we frequently say, always go into your investment with a plan, a set of goals, and a clear idea of what you plan to do and a realistic means of accomplishing it. Be sure to check back with us each week and follow us on Facebook for more advice and tips on investing in real estate!
- Get It Right Solutions LLC