When it comes to getting a lender’s approval to buy or refinance a home, there are 3 key numbers that affect your ability to qualify for a mortgage and how much it will cost you — your credit score, debt-to-income ratio, and loan-to-value ratio.
Here’s a rundown of what they are and why they matter.
Credit Score
You’re probably already familiar with this one. A credit score is a three-digit number, typically between 300-850, that measures a person’s borrowing history. There are three main credit bureaus (Equifax, Experian, and TransUnion) that each calculate their own credit score based on your payment history, how much debt you have, your credit limit usage, among other factors.
With your permission, lenders request your credit score from one or all of the credit bureaus through a ”soft” or “hard” credit check. A “soft” check is done earlier in the mortgage process, usually during a basic pre-approval. It doesn’t affect your credit score in any way.
A “hard” check is done when you’re ready to submit an application. It signifies to credit bureaus that you’re interested in opening a new line of credit, so it will have a small impact on your credit score (usually less than five points).
The good news is, credit bureaus will typically only dock your score once within a 30-day period when applying for a mortgage with different lenders. So, you won’t be repeatedly penalized, no matter how many “hard” credit checks are completed for mortgage applications during that time.
Why your credit score matters for your mortgage
Your credit score helps mortgage lenders evaluate how likely you are to pay back your loan. Most lenders have minimum credit score requirements to be approved for specific home loans. And, the higher your credit score, the better the interest rates your lender can offer.
For example, depending on the loan, a 20-point increase in your credit score could reduce your rate enough to save you thousands of dollars over the life of your loan. A higher credit score can also help lower your rate for mortgage insurance, which is required if you have less than 20% for a down payment or for loans with less than 20% equity.
Start off by getting your credit score for free through our basic pre-approval “soft” check (which doesn’t affect your credit score). If you have some time before you buy or refinance your home, consider improving your score to help you save on your mortgage.
Loan-to-value ratio
Your loan-to-value ratio (LTV) is a way to measure how much equity you have in your home. The LTV is the percent you still need to put toward the principal to fully own your home. The higher your LTV, the more you’re borrowing from your lender.
If you are buying a home, it’s easy to calculate your LTV. First, subtract your down payment amount from the value of the house. Then, divide that number by the value of the house.
For example, if your property is valued at $200,000 and your down payment is $20,000, then your LTV would be 90%.
200,000 – 20,000 = 180,000
180,000 / 200,000 = 0.9 or 90%
Another way to get your LTV is to subtract your down payment percent from 100%. So, if you’re making a 20% down payment, your initial LTV would be 80%.
If you are refinancing your home and want to calculate your LTV, divide the remaining balance on your mortgage by the value of your home.
For example, if your home is valued at $200,000 and your loan balance is $150,000, your LTV would be 75%.
$150,000 / $200,000 = 0.75 or 75%
Why loan-to-value ratio matters for your mortgage
For a home purchase, lenders often have a maximum LTV, or down payment minimum. Your exact LTV maximum depends on things like your property type (single-family, co-op, or multi-unit), your loan amount, whether you’re a first-time homebuyer, how you’ll be using the property, and so on.
If your LTV is greater than your lender’s limit for your circumstances, you’ll either have to increase your down payment or find a lower-priced property. If you buy a house with an LTV above 80% (meaning your down payment was less than 20%), your lender may require mortgage insurance.
For a home refinance, your LTV is important for several reasons. If you refinance when you have less than 20% equity in your home, then you may be required to pay mortgage insurance on top of your new monthly payment.
If you’re interested in a cash-out refinance for home renovations or debt consolidation, then you’ll likely need to ensure that your LTV stays at or below 80% post-refinance (for a single-unit primary residence; maximum LTVs for other properties may vary).
Your LTV will also be the deciding factor if you’re looking to get rid of mortgage insurance—and you may not need to refinance to remove it. The more payments you make towards your mortgage, the lower your LTV will be. When you pay off enough of your loan that your LTV reaches 78%, mortgage insurance for conventional, non-government loans cancels automatically. Mortgage insurance can also be cancelled slightly earlier, at 80% LTV, upon your request, given that you’ve met your lender’s criteria.
However, mortgage insurance for government loans, like FHA loans, can’t be cancelled and is paid for the life of the loan. For these loans, you would need to refinance to remove mortgage insurance.
Debt-to-income ratio
Your debt-to-income ratio (DTI) helps lenders understand how much you can afford to pay for a mortgage each month given your existing monthly debt payments. Lenders add up what your monthly debt will be once you have your new home (e.g., monthly payments for student loans, car loans, credit card bills, etc. plus your future mortgage payment) and divide it by your gross monthly income (i.e., how much money you earn before taxes).
Why debt-to-income ratio matters for your mortgage
Lenders set DTI limits to make sure that you can comfortably afford your mortgage now and in the future. If your DTI is higher than the limit for your circumstances, you may not be able to qualify for that mortgage. In fact, a high DTI is the #1 reason mortgage applications get rejected.
Most lenders typically offer loans to creditworthy borrowers with DTIs as high as 50%. Keep in mind that the lower your DTI, the easier it may be to qualify for a mortgage and if you have time before you buy a home or refinance, lowering your DTI can make the mortgage process go much smoother.
If you’d like to talk through these 3 factors and find out how they may impact your mortgage, we are here to help. Contact us anytime.