With record-low interest rates that may go away in the distant future, many would-be first-time home buyers are considering their options with regard to buying a home. In preparing to purchase a home, it will help to know what lenders are looking for when buyers apply for a mortgage with them. There are four components: down payment, credit, income and assets, and appraised value of the property.
Down Payment – Putting down at least 25% is ideal, in that buyers can avoid having to purchase mortgage default insurance on their loan. The higher the loan to value ratio, the more risk the lender is being asked to take on. This will result in higher interest rates for the buyer.
Credit – There are several components to this, including total debt, recent payment history, and ability to manage credit over time. These items give the lender a picture of the buyer’s ability to manage obligations over time. Of the above items, recent payment history is probably the most important. Prior to taking on a mortgage, buyers who are having issues making monthly payments such as those on a car will face questions as to how they will be able to manage after they move into a home.
Income & Assets – Lenders are looking for two to three years of stable employment history from borrowers. They use two ratios to determine if buyers qualify from an income perspective. The first is the GDSR, or Gross Debt Servicing Ratio. This is the ratio of total shelter expenses (mortgage, taxes, insurance) to gross income. Lenders are looking for this number to be in the 30% to 32% range. The second ratio is the TDSR, or Total Debt Service Ratio, which is the ratio of all financial obligations to gross income. Lenders here are looking for 40% to 42% maximum.
Ideally buyers will obtain a mortgage in which the principal and interest components of the payment amount will remain constant for as long as possible.
Should property values decrease, even if the income of the buyer remains the same, being able to refinance the mortgage at the end of the term could prove to be out of the question, at any rate. As far as assets go, the lender will want to know where the down payment is coming from, which could be from the buyer’s savings or perhaps via a gift from a close relative.
Property Value – The lender needs to know if the property is worth what the buyer and seller think it is worth. If there is a difference between the appraised value of a property and the contract price, the lender will take the lower of the two.