When deciding to purchase a home, the list of things to consider can be daunting. While you might be comparing square footage, finishes, and neighborhoods, mortgage lenders are looking at specific numbers that make up your financial picture with the same discerning eye.
You might be eager to look at homes online, or even swing by a few open houses, but without getting your finances in check, your offer could be the last to the table. Sitting down with a lender and getting pre-approved for a loan puts you in a strong position and will make your offer stand out on that home for sale in Denver, CO.
Evaluating your buying power isn’t the most exciting part of the home-buying process, but understanding how these numbers affect the chances of an offer being accepted is crucial for every prospective buyer.
- Credit score
- Down payment
- Debt-to-income ratio
Your credit score is one of the most basic ways a lender can determine your ability to pay your loan on time every month. Five key factors influence your score, each varying in importance: payment history (35%), amounts owed (30%), length of credit history (15%), credit mix (10%), and new credit (10%).
While a low credit score (think below 620) doesn’t necessarily mean you’ll be denied for a loan, it certainly impacts the quality of loan you’re offered. Interest rates for scores in the 580 to 699 range could be anywhere from 0.5% to 4% higher than the lowest rate available — and that will make your mortgage more expensive.
On the other hand, a score of 760 to 850 could land you the best possible rate, and a score of 700 to 760 could put you just 0.25% above the lowest rate.
Credit scores are playing a larger role, but cash is still king in the home-buying game. Regardless of how low your mortgage rate is, the ability to offer a serious down payment improves your overall buying power the most.
There are plenty of benefits to the often-repeated 20% rule of thumb, in which you come up with 20% of the home sale price in cash. Putting this much money (or more) into a down payment can eliminate the need for private mortgage insurance (PMI), and allow you to negotiate for a lower interest rate, and, in competitive markets, could place you above the competition.
For sellers, it all boils down to looking committed and financially ready to make such a hefty purchase. In turn, your high down payment could significantly lower the amount you pay over the life of your loan.
Making a nice, steady income is great, but not everything when it comes to determining your mortgage eligibility.
Lenders want reassurance that you’ll be able to pay your mortgage in addition to all other outstanding debts currently in your name. To do this, they will look first at your front-end ratio, or housing ratio — your monthly housing payment (including insurance, interest, taxes, and PMI, if applicable) divided by your monthly income. The general rule of thumb is to keep this at or below 28%.
Next, lenders will consider your back-end ratio or debt-to-income ratio, a calculation that determines how much of your monthly pay services your existing debt (e.g., car loans, student loans, credit card payments, etc.). This calculation is your total monthly debt payments divided by your total monthly household income. The general rule of thumb for this calculation is to keep it at or below 36%.
While landing above the suggested ratios won’t necessarily end your journey to homeownership, it can certainly impact your loan terms.
A lender’s biggest concern is always whether the borrower will have the income coming in and the financial resources already on hand to stay up to date on payments, regardless of other financial storms they may be weathering.
Therefore, you will be required to provide documentation of assets showing where money for the down payment is coming from and what your savings and investments currently look like. The bigger your cushion, the more likely lenders will think you can afford all mortgage costs and fees, and all other home-related financial obligations afterward.
The bottom line
Understanding the importance of these four numbers and making necessary adjustments before window-shopping can do wonders in ensuring your bank account will be ready when the time comes to make a purchase.