When it’s time to purchase a home, there’s a lot of things to get in order before applying for a mortgage. Lenders are more strict about credit and require a down payment. The amount most banks want is between 15 and 20 percent, though some borrowers qualify with less. A pristine credit file is just one factor among many.
Rates remain low for home loans, though are creeping up steadily and home values are on the rise as the percentage of properties for sale which are foreclosures, bank-owned, and short sales falls. With less distressed properties pushing down prices, home prices are going up. This, not to mention the fact that banks are wanting to add to their book business in order to move on from the lingering effects of the national economic downturn.
What you might not know is the fact that financial institutions, especially banks, are still in a state of recovery because they are dealing with the lasting effects of defaulted debt instruments. Hundreds of millions of dollars in defaulted mortgages, business loans, lines of credit, car loans, and more went unpaid by hundreds of thousands consumers. However, though banks are eager to make new loans, they are quite cautious about who they approve, and, will turn down some home loan applicants.
Your Debt-to-Income Ratio
One of the best measurements of how much you can afford in the form of a home loan is your DTI or Debt to Income ratio. This figure is the difference between your gross monthly income and your monthly obligations. Lenders like to see that number under 43 percent, but prefer it to be about 35 percent because it gives borrowers room.
“Evidence from studies of mortgage loans suggest that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments. The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage.” —Consumer Financial Protection Bureau
Among a wave of new federal banking regulations and consumer protection efforts, borrowers with a debt to income ratio of more than 43 percent, even with sterling credit and a hefty down payment likely will not qualify for a mortgage.
This means, of course, that it’s quite important to get your DTI in check and lower it as much as possible. Doing that starts with paying off lines of credit, building up your savings account, and streamlining other monthly obligations. A new car loan will inflate your DTI, and, that’s a bad thing.
Your Credit File, Score, and Mortgage Approval
To improve your credit score, you’ll have to review each report produced by the three credit bureaus: Experian, Equifax, and TransUnion. Your credit reports can be obtained free of charge once a year through Annual Credit Report.com.
You’ll want to go over each one with a fine-tooth comb and mail in letters, along with proof for each dispute on your report. Do not use the online dispute system because they do not contain enough space to explain the situation and not enough space to include proof of inaccuracies.
Of course, a car loan can be a good thing to improve your credit score; but, it has to be “aged”. In other words, if you’re considering applying for a home loan, wait at least twelve months after financing a new car. This will up your credit score and put at least some of the balance obligation behind.
It’s best to wait longer, about halfway into the loan or longer, to take time to payoff lines of credit and build-up your savings. Frankly, a high monthly car payment can do a lot to keep you from qualifying for a mortgage. For instance, a payment of $430 can reduce your borrowing power by as much as $100,000.