When you apply for a home loan, your lender will review your credit reports, check your credit score and pore over your finances to make sure you can afford your monthly mortgage payment. Along the way, your lender will look for certain financial missteps that might make him or her nervous about approving your application.
Late payments: Ever pay your credit card bill late? Maybe you skipped a car payment one month. The bad news? Those late payments will show up in your credit reports, which are maintained by the national credit bureaus of Experian, Equifax and TransUnion. And when you apply for a mortgage, your lender will have access to these reports to review.
Late payments remain on your credit reports for seven years. Fortunately, there is some leeway here: A payment is only considered late and reported to the credit bureaus if you pay it 30 days or later past your due date. Are you two weeks behind on your credit card payment? Pay it now, before it is reported as late to the credit bureaus.
Lenders will worry if your credit reports are dotted with late payments. And late payments also cause your credit score to fall, often by 100 points or more. Your best move? Always pay all your monthly bills on time.
Too much credit card debt: Lenders also consider your debt-to-income ratio when reviewing your loan application. This ratio measures how much of your gross monthly income — your income before taxes are taken out — your monthly debts consume. Most lenders prefer that your monthly debts, including your new mortgage payment, equal no more than 43% of your gross monthly income.
If you run up too much credit card debt, it could boost your debt-to-income ratio past this mark. It could also impact your credit utilization ratio, a measure of how much of your available credit you are using. Lenders like this ratio to be low. The more available credit card debt you are using, the worse it is for your credit score.
Are your credit card balances near their limits? That's a big red flag for lenders.
Not enough savings: You'll need plenty of savings to take out a mortgage loan. You'll need to save for both your down payment and to cover the closing costs that your lender charges to originate your loan.
But most lenders also want to see that you have enough savings after these expenses to cover at least two monthly mortgage payments. Lenders consider this a type of safety net: If you suffer a brief downturn in your monthly income, you can still rely on these savings to help make your mortgage payments.
What if you don't have any savings? This might make lenders nervous about approving your loan request. Make sure, then, to build up your savings before you apply for a mortgage.
Applying for a mortgage might sound intimidating, but the good news is that if you avoid these three financial red flags, your chances of qualifying for a mortgage will soar.
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