Buying a Home and Getting a Loan - What Banks Look At
This information will help you to understand what banks are looking for when someone applies for a loan when buying a home.
Your FICO Score - A FICO score is a credit score developed by Fair Isaac & Company to help lenders determine the risk involved in lending money to someone who is applying for a loan. It is one of the most important things lenders use to help determine eligibility as well as specific amounts, rates and terms that can be offered. FICO scores range from 300-850. The higher your score, the less risk there is in lending to you. There are some factors that influence your credit rating, i.e. your payment history, more than others. Your score can change frequently as new credit is established or paid down/off. All factors can be grouped into 5 main categories:
•Payment History – Do you make your payments on time? Since this determines about 35% of your score, it is obviously in your best interest to make all of your payments on time. They take into account: credit cards, car payments, mortgages, student loans and other loan types. Other items such as a bankruptcy are included in this group too.
•Outstanding Debt – Most people have debt but what FICO measures is how much debt you have. The outstanding balances for credit cards, car loans, mortgages, etc. will determine about 30% of your score. If you can significantly pay down or pay off credit card debt, this will really help during loan approval. But don’t close accounts that you pay off – leave them open.
•Credit History – How long have your current accounts been opened and how long has it been since you used each of them? This usually determines about 15% of your score. If you don't have a credit history yet, you should establish a few credit accounts and be sure to always pay them on time. The less credit history you have, the less you'll be able to borrow.
•Pursuit of New Credit– Every time you apply for credit, there is an inquiry note placed in your credit file. FICO looks at how many inquiries there are and how recent. If you recently applied for a couple of credit cards and a new car loan, you may want to hold off applying for a home loan for a few months. Each inquiry may slightly reduce your FICO score. This usually accounts for about 10% of your total score.
•Types of Credit in Use – How many types of accounts are reported for ATM cards, car loans, credit cards, travel accounts, or any other type of account where payments are being made? This makes up about 10% of your final score as well.
Once your bank is aware of your FICO score they may or may not choose to share this information with you. Assuming they do share your score with you, it is important to remember the higher the score, the more likely you are to obtain a loan. And a higher score also means you will be able to get lower interest rates.
A high FICO score is not the only determining factor in getting loan approval. There are additional factors are considered in the approval process as well. FICO scores aren't as important in FHA loans as with conventional loans. Some of these other factors include:
* Income – Your current income is a significant factor in determining loan approval. Pay stubs for the previous two months as well as W-2 forms for the previous year will be requested to help determine your ability to repay the loan amount.
* Employment History - which can tell a lender a lot about your stability. If you are constantly switching jobs, this might raise a red flag. However, for some people there are other factors that influence your employment length (such as a spouse in the military) and some lenders may choose to ignore this factor.
* Down Payment – The amount of money you have to provide a down payment is extremely helpful getting a loan.
The important thing to remember is that no matter what your FICO score, employment history or income level, there are things you can do to help improve your chances of obtaining loan approval. Get referrals to local non-profit credit counselors or financial advisors to help optimize your resources fully.
Important note: It is best to get your finances in order, including working on improving your credit scores, before you get serious about looking at homes.