How to Improve Your Chance of Getting a Mortgage

Buying a home is probably the largest single financial investment you’ll ever make and, if you’re like most people, you’ll need a mortgage to make it happen. While there are no guarantees that you’ll qualify for the mortgage you want, there are certain steps you can take that will make you more attractive in the eyes of lenders. Read on to find out the best tips for improving your chances of getting a mortgage.

Lenders review your credit report – a detailed report of your credit history – to determine whether you qualify for a loan and at what rate. By law, you are entitled to one free credit report from each of the “big three” credit rating agencies – Equifax, Experian and TransUnion –every year (see, What's On A Consumer Credit Report?). If you stagger your requests you can get a credit report once every four months (instead of all at the same time), so you can keep an eye on your credit report throughout the year.

Once you have your credit report, don’t presume everything is accurate. Take a close look to see if there are any mistakes that could negatively affect your credit. Things to watch out for:

• debts that have already been paid (or discharged)
• information that is not yours due to a mistake (e.g., the creditor confused you with someone else because of similar names and/or addresses, or because of an incorrect Social Security number)
• information that is not yours due to identity theft
• information from a former spouse that shouldn’t be there anymore
• out-of-date information
• incorrect notations for closed accounts (e.g., it shows the creditor closed the account when, in fact, you did)

It's a good idea to check your credit report at least six months before you plan to shop for a mortgage so you have time to find and fix any mistakes. If you do find an error on your credit report, contact the credit agency as soon as possible to dispute the mistake and have it corrected.

While a credit report summarizes your history of paying debts and other bills, a credit score is the single number that lenders use to evaluate your credit risk and determine how likely you are to make timely payments to repay a loan. The most common credit score is the FICO score, which is calculated from different pieces of credit data in your credit report:

• Payment history – 35%
• Amounts owed – 30%
• Length of credit history – 15%
• Types of credit in use – 10%
• New credit – 10%

In general, the higher the credit score you have, the better the mortgage rate you can get, so it pays to do what you can to achieve the highest score possible. To get started, check your credit report and fix any mistakes, and then work on paying down debt, setting up payment reminders so you pay your bills on time, keeping your credit-card and revolving credit balances low, and reducing the amount of debt you owe (e.g., stop using your credit cards). 

A debt-to-income ratio (see Debt Management Ratios) compares the amount of debt you have to your overall income. It’s calculated by dividing your total recurring monthly debt by your gross monthly income, expressed as a percentage. Lenders look at your debt-to-income ratio to measure your ability to manage the payments you make each month, and to determine how much house you can afford.  

If you have a low debt-to-income ratio, it shows you have a good balance between debt and income. Lenders like to see debt-to-income ratios that are 36% or lower, with no more than 28% of that debt going toward mortgage payments (this is called the “front-end ratio”). In most cases, 43% is the highest debt-to-income ratio you can have and still get a qualified mortgage. Above that, most lenders will deny the loan because your monthly expenses are too high compared with your income. 

There are two things you can do to lower your debt-to-income ratio, and both are easier said than done:

• Reduce your monthly recurring debt.
• Increase your gross monthly income.

The single most important thing you can do to reduce your monthly recurring debt is to buy less. Take a careful look at where your money goes each month, figure out where you can save and make it happen.

While there’s no easy way to increase your income, you can try to find a second job, work extra hours at your primary job, take on more responsibility at work (and get a pay increase) or complete coursework/licensing to increase your skills, marketability and earnings potential. If you're married, another option to increase your household income is for your spouse to take on additional work – or go back to work if one of you has been a stay-at-home parent.

Nothing shows a lender more that you know how to save like a big down payment. A large down payment reduces the loan-to-value ratio, which increases your chances of getting the mortgage you want. The loan-to-value ratio is calculated by dividing the mortgage amount by the purchase price of the home (unless the home appraises for less than you plan to pay, in which case the appraised value is used). Here’s an example. Say you plan to buy a house for $100,000. You put down $20,000 (20%) and seek a mortgage for $80,000. The loan-to-value ratio would be 80% ($80,000 mortgage divided by $100,000, which equals 0.8, or 80%).

You can lower the loan-to-value ratio by making a larger down payment: If you can put down $40,000 for the same house, the mortgage would now be just $60,000. The loan-to-value ratio would fall to 60% and it will be easier to qualify for the the lower loan amount. In addition to increasing your chances of getting a mortgage, a larger down payment and lower loan-to-value ratio can mean better terms (i.e., a lower interest rate), smaller monthly payments and less interest over the life of the loan.

When you're setting your down payment, remember that a 20% or larger down payment will also mean that g you won't be subject to a mortgage insurance requirement, all of which can save you money.

Tighter lending practices have made it more difficult to secure a mortgage. The good news is that there are steps you can take to improve your chances of qualifying for a loan, especially if you start early. Start the process by checking your credit report and fixing any mistakes, and then work on improving your credit score, lowering your debt-to-income ratio, and actively saving for your down payment.