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Mortgage rates are down! It may be a good time to refinance, or learn the income you need to buy a median-priced home in the top 50 metro areas!

Mortgage rates are down! It may be a good time to refinance, or learn the income you need to buy a median-priced home in the top 50 metro areas!

How to Get Approved for a Mortgage: Factors Affecting Approval

craftsman-home-gettyimages-1026205392If you're wondering, "How do I know I'll be approved for a mortgage?" read on. This article lists the factors that affect your mortgage preapproval, how mortgage underwriters evaluate your application, and what you can do to increase your chances of a good outcome.

Mortgage preapproval: It's the whole package

It's smart to apply for mortgage preapproval before shopping for a home. Mortgage approval involves several factors, including:

While there are minimum requirements for each element, it's the combination of all of them that determines whether you get the mortgage approval you seek. For instance, Fannie Mae allows FICO credit scores as low as 620. And debt-to-income ratios as high as 45%. And down payments as low as 3%. But not all three at once.

Ready to apply? See mortgage rates and contact lenders now.

Automated underwriting

Many mortgage lenders use automated underwriting systems (AUS) to evaluate loan applications. And while lender guidelines for manual (human) underwriting are generally available online, the calculations that take place in the software are less transparent. So the question, "How do I know that I'll be approved for a mortgage?" is not always easy to answer.

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Fortunately, you get a decision very quickly with AUS. In seconds, the software recommends mortgage approval, refers the file to a human underwriter, or recommends denial. So you could just apply online with a lender and find out first-hand.

Here are the factors that affect your mortgage approval, including minimum guidelines for conforming (Fannie Mae and Freddie Mac) programs, FHA, VA, nonconforming (jumbo) mortgages and portfolio loans.

Down payment needed to get approved for a home loan

Your down payment (or amount of home equity if you're refinancing) is a big component of the risk a lender takes when approving a mortgage.

Related: Need down payment help? Review homebuyer assistance in every state

In general, the higher your down payment, the lower your odds of default, and the better your chance of mortgage preapproval. You can often compensate for a lower credit score or income by making a larger down payment. Here are the minimum down payments for five common programs:

1. Conforming loans (Fannie Mae and Freddie Mac)

The minimum down payment for Fannie Mae's HomeReady program and Freddie Mac's HomeOne is just 3%. If you meet income eligibility requirements and complete a homebuyer education course, you may be eligible for this program, which offers more flexible underwriting. If you qualify, you can finance with a FICO as low as 620.

Otherwise, you can qualify through the standard 97% program with a credit score of 680 for DTIs at 36% or lower, and 720 for DTIs up to 45%. (Note: DTI equals your monthly bill payments divided by your gross income and it's explained below.)

One exception is that if you qualify for a Community Second mortgage (income limits and other rules apply), you can purchase a home with no out-of-pocket costs.

As of this writing, according to mortgage statisticians at Ellie Mae, the average down payment for a completed conforming purchase is 20%.

2. FHA home loans

The minimum down payment for FHA financing is 3.5% as long as your credit score is 580 or higher. And it's 10% if your FICO score is between 500 and 579. But the official guidelines don't tell the entire story. Very few FHA loan applicants get approved with the minimum down payment and those credit scores. In real life, you'll likely need more money down if your credit scores are on the low end.

Ellie Mae lists the average down payment for closed FHA loans at 5%.

3. VA home loans

The VA requires no down payment from its borrowers. But there are a couple of reasons that you might choose to make one. First, you can get a discount on your funding fee with a down payment of at least 5%. For instance, a first-time borrower with VA eligibility pays 2.15% for the funding fee with zero down, but just 1.5% with 5% down, and 1.25% with 10% down or more.

And if your loan amount exceeds the maximum VA guarantee limit, you'll need a down payment of at least 25% of the amount your loan exceeds VA limits. Currently, VA loan limits are 484,350 in most locations. So if you needed at $500,000 loan, you'd subtract $484,350 to get $15,650. And 25% of that is $3,912.50.

Ellie Mae claims that the average down payment for VA home loans is 2%.

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4. Nonconforming (jumbo) home loans

Nonconforming loans don't have standard guidelines. That's why they are called "nonconforming." A lender sets its underwriting standards according to the wishes of its investors. When a mortgage is nonconforming because of its size, it's called a "jumbo" loan. Most jumbo loans have fairly strict underwriting requirements because the loan amounts are high.

For a nonconforming loan, you'll need at least 5% down if you have excellent credit and a low DTI ratio. You won't qualify for mortgage insurance otherwise. If your credit score is at least 680, you're eligible for mortgage insurance with 5% down, up to $1 million. If you're borrowing up to $2 million, you'll need at least 15% down and a 740 or better credit score.

5. Portfolio loans

Portfolio lenders don't sell their loans, so they assume all the risk. And because they assume all the risk, they get to make their own rules. In general, portfolio lenders charge higher interest rates because they offer niche products for which there is less competition. These loans can be riskier than standard offerings.

Portfolio lenders, like traditional lenders, evaluate the overall risk of a loan before making an underwriting decision. If the lender makes a concession that allows you to use bank statements to prove your income, it's also likely to require a higher down payment (20% - 25%).

That's especially true if your portfolio loan allows low credit scores. (Portfolio loans that allow these are called "non-prime" mortgages.)

While 100% mortgages exist in portfolio lending, to be approved for credit, income and assets must be top-drawer. And expect to pay an interest rate of about 1% more than you would with a traditional loan.

Credit scores to get approved for a home loan

What credit score do you need to get approved for a home loan? That depends on the program. Here are the minimums for the most common mortgage programs:

  • Conforming: 620 with 25% down and DTI < 36%, or with 3% down for HomeReady/HomeOne
  • FHA: 580 for 3.5% down, 500 for 10% down
  • VA: No official minimum credit score. However, many lenders set a minimum score of 620 - 640.
  • Nonconforming jumbo: 680 - 740 depending on your loan size
  • Portfolio: 500 and up depending on your down payment

Related: How to find and fix errors on your credit report

Your lender also has other credit guidelines. You may not get mortgage preapproval if your credit report contains recent bankruptcies, foreclosures or other serious events like judgments, liens, repossessions or deeds-in-lieu of foreclosure. Even if your credit score beats the minimum, it's often a judgment call made by a human underwriter.

Ellie Mae reports that the average FICO for closed home loans is:

  • Conforming: 751
  • FHA: 675
  • VA: 708

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Debt-to-income (DTI) to get approved for a home loan

The factor that most determines if you can afford a mortgage is your debt-to-income ratio, or DTI. Your DTI is the relationship between what you earn and what you borrow or spend. You calculate it by dividing your total monthly payments by your gross (before tax) monthly income.

Try this Home Affordability Calculator to see how much you can afford to borrow

Don't include household expenses like food and gas in this ratio. Just your proposed housing expense, including principal, interest, property taxes and homeowners insurance (PITI), plus the minimum payments on your credit cards and any installment accounts like auto financing and student loans.

Most programs allow maximum DTIs between 36% and 45%. However, with compensating factors, you may be able to get approved with a DTI as high as 50%.

According to Ellie Mae, the average DTI for closed loans is as follows:

  • Conforming: 36%
  • FHA: 44%
  • VA: 43%

If your numbers are in line with average figures for closed loans, you have a good shot at mortgage approval.

Assets (reserves)

What are reserves when you apply for a mortgage? Reserves are liquid funds or marketable securities in savings, checking, investment and retirement accounts that you could use to pay your mortgage if your income stopped.

Reserves are measured in months. For instance, if your mortgage PITI equals $1,000 a month, and you have $11,000 in savings after closing on your home loan, underwriters say that you have 11 months of reserves.

For conforming mortgages, reserve requirements range from zero to six months. To qualify with zero reserves when you buy a home, you need at least a 640 credit score with a DTI of 36% or less, or a score of 680 with a DTI up to 45%.

FHA and VA guidelines don't specify reserve requirements. But having at least two months can be considered a compensating factor.

Portfolio lenders often have reserve requirements. Especially if you are proving your income using bank statements instead of tax returns. Two-to-six months is typical.

How to get approved for a mortgage with compensating factors

"Compensating factors" are additional considerations that don't rise to the level of an underwriting requirement, but can help you push the envelope when qualifying for a mortgage. Here is a list of some common compensating factors:

  • Minimal payment shock (this means your new house payment including PITI won't be much higher than your old rent or mortgage)
  • Conservative use of credit (if your credit score is lower because you don't use much credit, lenders take that into consideration)
  • Habit of savings (show regular deposits into a savings account)
  • Job with upside (if you are in a field likely to deliver higher income in the future -- for instance, you're graduating from dental school -- lenders often approve a higher DTI)
  • Very high credit score
  • Income from boarders, a "trailing spouse" who will find a job after you move in, or earned income that you can't use to qualify because you don't have sufficient history (like a second job you've had for six months)

Compensating factors most often come into play when your application gets a "refer" recommendation from an automated system, or when human underwriter evaluates your loan application.

FAQs for getting approved for a mortgage

Here are some common questions borrowers have about mortgage loan approval.

Should I apply with more than one mortgage lender?

If you have doubts about being able to get approved for a mortgage, applying with more than one lender can make sense. This is especially true if you're under contract to buy a home and can't risk being declined. However, it's smarter to apply for mortgage preapproval before you shop for a home.

Why would you apply with more than one lender? Because some mortgage lenders impose stricter guidelines than the official ones of Fannie Mae, the FHA or VA. These are called "overlays" and can get you turned down even if you qualify under the basic guidelines.

Alternatively, you might want to apply for two different programs with the same lender. It's easier. FHA mortgages have more forgiving guidelines, but the mortgage insurance is expensive. So if you're not sure you'll be approved for a cheaper conforming mortgage, apply for an FHA loan as well. This way, you have a backup approval if you need it.

What should I do if I'm declined for a mortgage?

If you're declined for a mortgage, your first step is to find out why. By law, mortgage lenders must issue an Adverse Action Notice when they turn you down or offer less-desirable loan terms that you wanted -- for example, a lower loan amount. Once you know what the reason is for denial, you can take action:

  • Appeal the decision (if the lender based its findings on inaccurate information)
  • Apply with another lender (ask in advance about overlays if that's what tripped you up)
  • Apply for a different program (government-backed loans are more forgiving, or you may need a non-prime or other portfolio program)
  • Adjust your loan amount

Being declined for a home loan is nothing to be ashamed of. It just means you need to adjust your tactics or your expectations.

How can I improve my chances of mortgage approval?

You can improve your approval chances if you don't go in blind. Here's what you can do upfront before applying for mortgage preapproval:

  • Pull your credit report at www.annualcreditreport.com and get your credit scores for a small fee. Fix inaccurate derogatory information and/or boost your score by paying down debt
  • Pay your debts down as much as you can to minimize your DTI and boost your credit score
  • Choose a loan amount that you can afford -- the lower the DTI, the better
  • If your credit score is not-great, document compensating factors and increase your down payment
  • Look at the down payment, DTI and FICO scores listed by Ellie Mae. If you're below average with your down payment or credit score, or have a higher-than-average DTI, you'll need to improve that or compensate with better-than-average everything else
  • Respond quickly to requests from the underwriter
  • Be honest with your loan officer or mortgage broker about potential problems. If your loan professional knows about these things upfront, he or she can help you compose letters of explanation or document compensating factors to help your case

Does applying for mortgage preapproval hurt my credit?

Credit scoring models used today have provisions for rate shopping built in. So they generally count any mortgage inquiries within a short time period (14 to 45 days, depending on the version) as one. And according to MyFICO, that inquiry only knocks about five points off of your score.

Related: HSH.com's comprehensive mortgage preapproval guide

How long is a mortgage preapproval good?

In most cases, a mortgage preapproval is good for 90 to 120 days. However, you can keep it in force by updating your loan file every time you get a new pay stub or bank statement.

To maintain mortgage approval, don't change jobs, apply for new credit or increase your account balances. And don't change programs unless you don't mind starting your preapproval over.

How much does mortgage preapproval cost?

Mortgage preapproval costs little or nothing, so there is every reason to pursue it. You may have to pay for a credit report, which the lender can't legally mark up. That's anywhere between $15 and $75 depending on the type of report.

Very few mortgage lenders charge application fees. Once you have a property picked out, you'll pay several hundred dollars for an appraisal. If you lock in your rate for an extended period (more than 30 days) you may have to pay an upfront fee.

It's smart to get mortgage preapproval before shopping for a home. And the best way to find out if you can be approved for a home loan is to simply apply online.

Contact mortgage lenders now for today's rates and programs.

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