3 Key Things Mortgage Lenders Are Looking for

To qualify you for the best rate, lenders will see if you pass muster in three main areas. Note that you may be able to offset weakness in one category with strength in another.

Are you a good credit risk? One of the first things lenders do is pull your credit score. The most common is the FICO score, which will be based on data from one of the three major credit bureaus (Equifax, Experian and TransUnion). Lenders use the lower of two scores, the middle of three or the average of all scores. If you have a co-borrower, they compare your scores and use the lower of the two or average them. Your debt-to-income ratio and your down payment determine the minimum required credit score for a mortgage.

Can you handle the payments? To measure “capacity,” lenders scrutinize your (and your spouse’s) job and income history and prospects, debt-to-income ratios, and savings and assets. Lenders will also look at your proposed ratio of monthly housing expenses to income. Housing expenses include loan principal and interest, real estate taxes, and hazard insurance (PITI), plus mortgage insurance and homeowners-association dues. Housing expenses generally shouldn’t exceed 25% to 28% of your gross monthly income.

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Lenders also figure your maximum debt-to-income ratio (total monthly debt payments divided by gross monthly income). That number and your down payment determine the minimum required credit score; if it’s 36% or less, Fannie Mae sets a minimum credit score of 620 with a down payment of 25% or more, and 680 with less than 25% down. To push the debt-to-income ratio to 45%, you’ll need a credit score of at least 640 with a down payment of 25% or more, and 700 with less than 25% down. Standards get tougher as you layer on more risk—say, with an adjustable-rate mortgage or investment property.

Does the value of the home justify the loan you want? “Collateral” is typically measured as loan-to-value ratio: the amount of the loan divided by the appraised value of the home you want to finance. If you could borrow all of the money, the LTV ratio would be 100%. But lenders will demand a down payment of at least 3%. That way, you have a stake that you stand to lose if you default on your loan.