WHAT BANKS ARE LOOKING AT TO GET APPROVED FOR A HOME LOAN

Are you ready to buy a house, or in the planning stages of a home purchase? Either way, it helps to know what banks look for when they evaluate your loan application. Banks need to make sure you鈥檙e likely to repay a home loan according to the terms of your mortgage agreement. In making this assessment, they consider a variety of factors related to your past and present financial situation.

What specific financial information will the banks look at? Here are a few items virtually all lenders consider before approving a home loan:

1. Credit Score
Also known as your FICO score, this number between 300 and 850 helps banks get a handle on your past credit history. The higher the number, the better. A low credit score tells banks you鈥檙e a risky borrower, and it could be harder to receive a loan.

How is your credit score calculated? By using a variety of metrics such as:

鈥 Payment history. Do you pay off your credit cards every month or carry a balance? Payment history influences your credit score more than any other factor. A history of timely payments will help your score stay high.

鈥 Credit utilization. This is the amount of credit you use versus the credit you have available. Let鈥檚 say your credit card has a $9,000 limit. A balance of $1,800 indicates 20% utilization while a balance of $8,100 indicates 90% utilization. The former is better for your credit score as 90% utilization suggests you鈥檙e too overextended to pay bills on time.

鈥 Length of credit history. The longer your history of paying balances and paying back loans, the higher your score is likely to be.

Factors such as the number and types of new credit accounts opened also impact your score, albeit to a lesser degree. Check out FICO鈥檚 rundown of credit score metrics for more on how your score is calculated.

2. Income
As far as banks are concerned, how much money you make isn鈥檛 nearly as important as your monthly income with respect to total monthly housing costs. You don鈥檛 necessarily need a high income to qualify for a home loan, but your income will influence the loan amount for which you鈥檙e approved.

To ensure you have sufficient income to cover monthly mortgage payments, lenders will consider your total monthly income from all sources. This total will include salary and bonuses as well as income from dividends and interest.

A good rule of thumb is not to purchase property when the monthly mortgage payment, insurance, and property taxes add up to more than one third of your monthly income. Banks are more likely to approve home loans if the monthly payment falls at or below that range.

3. Current Loans
Do you have long-term, ongoing debts for things like car payments and student loans? Lenders will look at whether such payments could affect your ability to pay back a mortgage.

Having these loans isn鈥檛 necessarily a bad thing鈥攅specially if you demonstrate a history of timely payments鈥攂ut banks do want to get a handle on the extent to which the expense already eats into your income. If you don鈥檛 have much left over after making those payments each month, it could affect your loan eligibility.

4. Down Payment Percentage
Homebuyers ready to put down 20% stand a better chance of receiving a loan. And if you can come up with more than that鈥攅ven better!

Gone are the days of easy, tiny down payments. Banks want you to have significant equity from the get-go, and 20% is generally the standard for proving you鈥檙e a serious, capable buyer. You should also learn what escrow is and how it impacts your down payment.

Remember: The 2008 financial crisis showed how damaging it can be for banks to extend home loans to borrowers whose ability to repay is suspect. That鈥檚 not to say you won鈥檛 receive a loan if you can鈥檛 put down 20%鈥攜ou might still be approved鈥攂ut keep in mind that banks are much more risk averse than they used to be.

If you aren鈥檛 ready to pay a 20% down payment, there are government insured programs that allow you to pay less up-front. Borrowers can get a Federal Housing Administration (FHA) loan for as little as 3.5% down. FHA loans require the borrower to pay for mortgage insurance, which gives the lender confidence should the borrower default.

Getting the Approval
Approaching a bank for a home loan means being prepared. An attractive credit history, sufficient income to cover monthly payments, and a sizeable down payment will all count in your favor when it comes to getting an approval.

Ultimately, banks want to minimize the risk they take on with each new borrower. Having your finances under control removes a lot of risk from the equation鈥攏ot just for the banks, but for you as well.