Keep in mind
Putting your financial data (salary, debts, etc.) into an online mortgage calculator gives you only half the picture. A website calculator cannot factor in your credit score, which weighs heavily in the interest rate and monthly payment amount of any mortgage.
You don't want to wait until you've found a house before you find out how much money a bank is willing to lend you. You can take the guesswork out of determining how much home you can afford by getting pre-qualified for a loan by a mortgage lender before you start house hunting.
Qualifying for a mortgage loan
Lenders will consider your existing debt when determining how large a mortgage to grant you. They are interested in your long-term debt, which is defined as any debt that will take more than 10 months to pay off. If your monthly debt payments are excessive for your income level (based on the lender's qualifying guidelines), your debt can significantly reduce the amount you will be able to borrow. For every $50 of "excess debt," you can expect about a $5,000 reduction in the amount you can borrow. If your debts are excessive, you would be wise to pay down your bills before seeking pre-qualification.
If you have any doubt about what size mortgage you will qualify for, having a lender pre-qualify you for a given amount will be well worth the small amount of effort. Although you can complete the calculations using a web-based mortgage calculator, contacting a lender or mortgage broker will also give you an opportunity to discuss what types of mortgages might be available specifically for you.
Your credit record
In calculating your request for pre-qualification, the lender will order a credit report on you (and any co-borrowers) to determine your credit-worthiness. Lenders want to see a track record of debts owed — and duly paid. They also want to confirm the total amount of debt you are carrying, as well as the total amount of credit available to you.
Credit scoring is a statistical method used to predict the likelihood that a potential applicant will repay a credit obligation, such as a mortgage loan. Today, credit scoring is becoming more and more widespread, making it critical that you obtain a copy of your credit report before you apply for pre-qualification. Check your credit report for errors.
This may help
The Fair, Issacs Company has published informative brochures regarding credit scoring, identity theft, and interpreting your FICO score.
Your FICO Score PDF
About Credit Scoring
A credit score is based only on information contained in the report. A credit score is not based on factors prohibited under the Equal Credit Opportunity Act (ECOA), such as race, gender, religion, national origin, nor marital status. Also excluded from the credit score are income, employment, and residence. What is included is:
- previous credit performance
- current level of indebtedness
- amount of time a particular line of credit has been in use
- the pursuit of new credit
- types of credit available
The most common credit scoring used in mortgage lending is based on a model developed by the Fair, Issacs Company and is known as a FICO score. The broad categories of credit data that are included in your FICO score are:
Payment history (approximately 35% of your FICO score)
Have you been a little late paying your bills? If so, how recently did these late payments occur? How long did you remain delinquent on any bill at one time? What is the highest level of delinquency reached in the last year? How many months have passed since the most recent negative item on record (a judgment, lien, bankruptcy, etc.). Generally, the better your credit performance, the better your credit score.
Amounts owed (approximately 30% of your FICO score)
How many consumer loans and open charge accounts do you have? What is the ratio of revolving debt to total revolving limits available to you? What is the percentage outstanding on installment loans? Generally, the higher the percentage in your utilization of credit, the higher the risk. It is best not to "max out" your credit cards, and a good rule of thumb would be to have your outstanding balance on all credit cards to not exceed 30% of your credit limit.
Length of credit history (approximately 15% of your FICO score)
How long have you had a line of credit? How long have you had your credit cards? Generally, the longer you have had credit, and successfully managed it, the better your credit score will be. When you pay off a credit card, do not cancel it without consulting a mortgage or financial counselor. Lenders like to see a history of managed debt. The longer you own a credit card, the better your credit score.
New credit (approximately 10% of your FICO score)
Are you currently pursuing new sources of credit, such as a car loan? To measure such activity accurately, the credit score calculation takes into account only inquiries initiated by you. The credit score model does not include inquiries you did not initiate, such as bank mail promotions, pre-screened credit card offers, and lines of credit promoted to you — whom the bank would like to issue credit. Such inquiries appear on your report as PRM, or promotion inquiries, and do not influence your credit score. The score takes into account inquires initiated by you over a 12-month period. Any inquiries related to automobiles and mortgages that occurred in the past 30 days are excluded. If multiple automobile or mortgage inquiries occur in any 14-day period, they are considered as a single inquiry.
Type of credit in use (approximately 10% of your FICO score)
What types of credit do you have? Department store credit cards? Bank credit cards? Installment credit with a local furniture store? Generally, bank-issued credit cards count the most on your credit report. It is important to keep these types of credit in responsible management. Often, the type of credit available to you on your report is an important factor in determining a credit score, but not as much as the other categories described above.
In addition to FICO score to assess your credit-worthiness, some of the largest mortgage companies and banks are also using a credit score model developed by VantageScore Solutions. The Vantage credit score, the primary competitor to the long-dominant FICO credit score, rates borrowers on a scale range of 501 (the highest risk, or subprime) to 990 (the lowest risk, or super-prime). Unlike Fair Isaac Corp.'s FICO scoring system, whose scores can vary by 50 to 100 points based on which bureau supplied the underlying credit data, Vantage scores remain consistent for each consumer.
If you have no credit record, either good or bad, the lender may not issue a mortgage loan because they cannot determine whether you are the kind of person to pay back a debt or not.
Before you begin looking at houses, you should know that now is the time to establish a credit history. If you do not have a traditional credit record that shows payments made to credit card companies, or a car loan, or a student loan, it is still possible to establish a non-traditional credit history by documenting your monthly rent payments to previous landlords (ask for receipts), payments to utility companies, cellphone companies, and even your monthly cable bill. If you pay monthly bills for health insurance or life insurance, include those receipts as well. Bring them to your mortgage broker, or better yet bring them to us, and we will represent you when applying to a lender.
Repairing bad credit
If you have not-so-perfect credit, or if you find that your credit report is not as clean as you want it to be, you may not be in a position to buy a house until these items on your report are resolved. To apply for a mortgage and to be rejected (and have the rejection also put on your credit report) would just compound your problems. Current activity in your credit history is counted heavier than items in your distant past, and if you have less-than-perfect credit this is to your advantage when trying to repair your credit. By law, most unfavorable credit information must be dropped from your credit file after 7 years. A bankruptcy remains on your credit report for 10 years.
If you are behind in your bills and feel overwhelmed by your debts, you should consider visiting a credit counselor. They can help you find ways to solve current financial problems, and can be found in the local yellow pages. Try to avoid companies who promise to provide a quick and easy way to perfect credit. Most of these organizations are simply a waste of money, or at worst they urge you to create a new credit identity. This is called file segregation, and it is illegal. The simple truth is that if your credit needs repairing, the best person to do it is you.
Incorrect information on your credit report
Unfortunately, it sometimes happens that credit reports are inaccurate or give a misleading picture of past credit problems that have already been resolved. You should obtain a copy of your credit report before you apply to become pre-qualified for a home loan to avoid unpleasant surprises. You don't want to take the chance that you could be denied on the basis of an erroneous credit report.
If you find any errors on the report, you have a chance to get your credit corrected. If you have an unresolved dispute with a creditor, the agency must include your explanation of the situation in future credit reports. The National Foundation for Credit Counseling (NFCC) is a national non-profit network of 1,450 member agencies designed to provide assistance to people dealing with credit conflicts. To find your nearest NFCC member, call 1-800-388-2227.