When you apply for a home loan a lender considers many factors. However, the underwriting process can be broken down into three broad categories called the "Three Cs" of Mortgage Lending: Capacity, Credit and Collateral.
Lets take a look at what they mean and how they impact your ability to qualify for a home loan.
This refers to the applicant’s ability to make timely payments, based upon Income and Current Debts.
First they consider the applicant’s income to determine if it is stable and likely to continue. It is not necessary to have worked any specific period of time at your current job. Rather the lender will look at your income history. Has it continued without a major interruption over last several years even if there has been job changes? If the income you need to qualify for the loan is dependent on over-time or bonuses, the lender will want to know how likely it is that these extra sources of income will continue.
Self-employment income is verified through prior tax returns which are verified with IRS. Casual, cash income that comes from jobs such as gardening and child care services can be considered as qualifying income for a mortgage, but usually there is a limitation on the amount of casual income that can be considered. Typically, lenders can consider the total household income as qualifying income for the mortgage.
Next the lender will analyze your other non-housing debts such as credit card payments, personal loans and car payments. These debts along with your proposed new mortgage debt will be compared to your total gross income. Typically, lenders will want this ratio (called the "back end" ratio) to be in the range of 38%. However, if you have experience successfully making higher payments or have exceptionally good credit, higher "back end" ratios are possible.
Your lender will also make a determination about your willingness to repay your loan in a timely manner.
This is done by analyzing your credit reputation. The primary method for verifying this is by reviewing your credit report from all three major credit bureaus. The lender will primarily focus on your credit behavior over the last 24 months prior to loan application. However, credit problems prior to that time will need to be explained.
Sometimes credit problems are the result of factors beyond that client’s control. In underwriting terminology, these are called "extenuating circumstances". Basically, any event that resulted in an unavoidable increase in expenses (i.e. uninsured medical bills) or a decrease in income (i.e. loss of job) is considered an extenuating circumstance. You should carefully review any negative credit items in your past and determine if they fall into this category and be prepared to document what happened. However, it also possible that some people developed credit problems due to financial mismanagement.
Depending on the reason for the credit problems, extenuating circumstances or financial mismanagement, the credit reestablishment period is usually 12 to 24 months. You will need to be able to show to your lender that during that period of time no new serious credit problems have occurred and that you have re-established new credit. Both factors are important. It is not enough to have avoided credit problems during that time, you must also establish a new positive credit reputation, typically with at least three creditors.
Bankruptcy and prior mortgage foreclosures are included in the definition of "credit problems". However, the credit re-establishment period for a prior mortgage foreclosure is longer, typically 36 months. Bankruptcies must be discharged.
Some borrowers have never relied on traditional sources of credit such as credit cards or car loans. As a result, their credit bureau report may indicate that their credit history is insufficient. However, borrowers that can demonstrate a positive payment history with non-credit payment references such as utility companies, rent history, insurance premiums and other sources, can be approved.
Before you can close escrow, your lender must verify the home you want to buy...which will be the collateral for your loan... has sufficient market value to adequately secure the loan in the event of a default.
This verification is done by the appraiser who inspects the property and compares its features, amenities, size and location with similar properties that have recently sold. This process protects both the lender and the home buyer.
Finally, the lender will consider the sources and amount of cash you have to make the required down payment and pay any required closing or settlement costs. Most mortgage loans have a minimum borrower down payment requirement. This down payment must come from your own funds. It can not be borrowed or be given to you as a grant or gift. Your lender will tell you how much you will need to verify as coming from your own funds.
Typically, if you can show that the funds have been in your bank account for at least three months, you will be able to meet this requirement. The other funds necessary to close the purchase of your home can come from a variety of sources such as public agency loans or gifts or grants from relatives.