Inside the mortgage process: how lenders determine interest rates and loan amounts.

Inside the mortgage process: how lenders determine interest rates and loan amounts.

Think you’re ready to make the jump from renting to buying? Ultimately, owning a home comes down to affording the mortgage payment. Here’s an inside look at how lenders will look over your finances when approving you for a loan. Along with some proactive ways to position yourself to confidently afford the home you want.

Understanding Ratios

Lenders rely on two ratios—the front-end and back-end ratios—to determine how large of a monthly mortgage payment you can afford.

The front-end ratio determines how much of your monthly income will go toward your mortgage payment, including principal, taxes and insurance. Lenders want your mortgage payment to take up no more than 28 percent of your monthly income.

The back-end ratio takes into account all of your debt, like your mortgage payment, credit card debt and student loans. Lenders want your monthly debt to total no more than 36 percent of your gross monthly income.

Takeaway: calculate your personal debt-to-income ratio to get a sense of the monthly payment lenders will expect you to afford.

Down Payments

Most conventional lenders require at least five percent of your home's purchase price as a down payment. Requirements will vary though, based on your credit history and other factors.

What do most people put down? According to EllieMae, statistics for 2016 indicate that, with more and more first-time homebuyers entering the market, down payments percentages have decreased, with fewer homebuyers putting down 10 percent, and many putting down even less. What’s more, if you take out a mortgage loan insured by the Federal Housing Administration, though, you'll need a down payment of just 3.5 percent depending on your credit score.

Takeaway: the more money you can put toward a down payment, the smaller your mortgage and the smaller your monthly payment will be.

How Your Credit Affects Interest Rates

Lenders rely heavily on your credit score when determining two things:

  1. The mortgage amount you’ll be approved for
  2. The interest rate they’ll give you

If you've made wise financial decisions and you've paid your bills on time, your credit score should be solid. In general, lenders reserve their best interest rates for borrowers who have FICO credit scores of 740 or higher.

What makes a credit score drop? Among other factors, things like missing payments, filing for bankruptcy, suffering through a housing foreclosure, or having lots of credit card debt can negatively affect your score.

Takeaway: the best way to get a low rate is to come to your lender with a strong credit score. If you’re unsure of your score, there are many places to check it online for free.

Have other questions about the home buying process? Talk to one of the experienced mortgage loan officers at Liberty Bank—we’re here to help guide you through the process.


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