How to Improve Your Chances of Getting a Mortgage

The following is an excerpt from Buying a Home: The Missing Manual.

Before you apply for a mortgage, improve your chances of approval by putting your financial house in order.

• Improve your FICO score. If you've got a blot on your credit history that's pulling down your score—or if you just want to bump up a "good" score to a "very good" or "excellent" rating—take steps to improve your score well before you apply for a loan. Because your FICO score reflects your behavior as a borrower over time, it can take months or even years for a score to improve. Follow these tips to move up the FICO scale:

• Pay your bills on time. If you tend to forget exactly when each bill is due, set up automatic withdrawals to make sure payments get made when they should.
• If you're behind in your payments, get caught up as soon as possible—and then pay on time. The longer you keep your accounts current, the more your score improves.
• Reduce your credit card balances. High balances on revolving accounts pull down your score. If you're carrying a high balance on one or more cards, pay down the amount you owe.
• Reestablish a good payment record. If you've run into trouble with credit accounts in the past, open a new account and be meticulous about using it responsibly—don't borrow too much and be strict about making payments on time. It takes time to rebuild good credit, so be aware that it may take years for your score to recover.

• Don't quit your job. Lenders look for income stability. If you're a job-hopper, or if you leave a job shortly before you apply for a mortgage, you may look like a higher risk than if you've been employed consistently for the last several years.
• Reduce your overall debt. As Section 2.3 explains, lenders don't like total monthly debt that exceeds 36 percent of your gross monthly income. If you carry a lot of debt, the bank will scale back the amount of money it's willing to lend you. Reducing your debt makes you look like a better risk, and the debt won't squeeze your monthly PITI too far below its 28 percent ceiling.
• Spend small. The flip side of reducing your debt is making sure you don't increase it. For at least six months before you apply for a loan, avoid buying big-ticket items, such as a new car or a washer/dryer set or anything else you need to buy on credit.
• Boost your down payment. As you'll see in Chapter 6, lenders like to see hefty down payments, because the greater the investment you make out of your own pocket, the less likely you are to default. If you can put down more than 20 percent toward the purchase of your home, you'll find it easier to get a loan than with a lower down payment.
• Don't apply for a lot of new credit. As Section 2.3.4.1.3 explains, lenders look at how long you've maintained your accounts and want to see responsible repayment over time. Opening a lot of new accounts at once may make you look desperate for some quick cash. It also affects your debt-to-income ratio (Section 2.3).
• Don't cancel existing credit cards. Lenders are interested in how much money you currently owe in relation to the credit you have available. This is called the credit-utilization ratio. Say you've got three credit cards, each with a $10,000 credit limit. That means you've got $30,000 in available credit. If you have a $7,000 balance on one of those cards, a $2,000 balance on the second, and a zero balance on the third, you're using 30 percent of your available credit. But if you cancel the zero-balance card, your available credit drops to $20,000, which makes your credit-utilization ratio soar to 45 percent. Using a higher percentage of your available credit makes you look riskier to lenders.

Comments

[Money Reasons]

I wonder if the requirements are the same for commercial rental property too.

Perhaps with rental property, a decent downpayment would be required now vs the days of 0% down...

[The Extra Money Blog]

Money Reasons, as an investor in real estate, I can tell you from experience that commercial properties work fundamentally in the same way. Most investors buy property under their established legal entities such as an LLC, in which case the lenders are interested in how much is the entity's net worth as well as whether it is established - and if so what kind of cash flow it is generating. One can always provide a personal guarantee.

For residential rentals, the down payment on rentals was never 0 down even in great times, unless one lied to the lender and mentioned they are buying it for themselves. Rental properties always require more in down payment, as well as a higher interest rate.

I'd like to specifically add to one bullet on the post above:

"Reduce your overall debt" - this is true. Specifically, if you are used to having an average amount of X on your credit card every month, even if you pay it off it full, it is beneficial to bring this average down as low as possible at the time of applying for a mortgage. if you are paying off your cc in full each month anyway, chances are you have the cash. Bite the bullet and pay cash for purchases in the month you apply for mortgage.

[Jessica]

Great post. I am actually in the process of buying a home, and know how important it is to have an excellent credit score to get the best rate.

[Kris]

If you've had credit problems, like late pays, get a credit repair manual and ask to have them removed. If you go about it the right way, you'll be able to get at least a few removed and improve your credit score.

[Steve]

What if you have declared bankruptcy like I have before? Then I believe you will need to do more to improve your credit score, and then have a better chance to get a mortgage. Even after you have filed for bankruptcy, as long as you are on the way to improve your credit, you are still eligible for the FHA loan.