When applying for a mortgage loan, borrower candidates face more scrutiny today than in years past. Lenders carefully assess credit-worthiness and ability to repay the loan by looking at income, credit score and history, employment history, tax returns, bank statements and debt. Those with large amounts of debt have a hard time getting affordable interest rates, and they may struggle to find a lender who is willing to give them a mortgage.
Consequently, it's important to take inventory of your financial status prior to shopping for a mortgage, says Doug Lebda, founder, chairman and CEO of Lending Tree, Charlotte, N.C.
"You'll want to assess your debt and prioritize payments and amounts," Lebda says. "Having maxed-out credit [cards and accounts] rarely sits well with lenders. Ideally, you'll want to pay down as much as possible while remaining current on your payments. This means paying more than the minimum payment on your bills, paying bills before they are due and getting a copy of your credit history so you can investigate and correct any outstanding debts or incorrect charges."
Potential homebuyers should check their credit reports – available from each of the three nationwide credit-reporting agencies, Equifax, Experian and TransUnion – for no charge every 12 months at AnnualCreditReport.com. If there are inaccuracies or errors, contact the credit-reporting agency and the information provider; the Federal Trade Commission offers more tips on how to dispute credit errors at http://www.consumer.ftc.gov.
If you have liens or collections on your credit report, get them resolved as soon as possible, says Carol Lynn Upshaw, vice president of Private Mortgage Services in Atlanta.
"You'll also want to talk to a mortgage broker to get pre-qualified to determine what your debt-to-income ratio is and then decide if you need to pay down some balances so you can purchase more house," Upshaw says.
Lebda says that the standard debt-to-income ratio when determining a person's "lendability" is 28:36, meaning that 28 percent of total monthly income (before taxes) can go toward the mortgage payment and 36 percent of total income can go toward the total monthly debt. An acceptable level of debt is approximately 8 percent of total pre-tax income.
Additionally, potential homebuyers must understand how much they can afford before hunting for a mortgage.
"Make a budget and live by that budget. Get everybody in your family on board and be committed to working together for what could be a long process. It could even take a few years [to get out of debt]," says Rodney Powell, broker, Powell Real Estate, Tomball, Texas. "Start paying off bills, and don't buy any new stuff or take vacations."
It might sound too simple to be true, but the key to debt reduction is simply not spending more than you have. Credit cards make it too easy to break this rule, so Lebda says, "Consider reducing or discontinuing the use of your credit cards until you can comfortably manage a zero to low card balance."
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