What are Lenders Thinking?

WHAT ARE LENDERS THINKING?

Lenders are all about risk assessment. Less risk translates into lower interest rates and more loan choices. If the lender views the risk as too great, that lender will deny the loan. Higher risk can also mean more documentation is required of you, the borrower. How do lenders measure risk? They use four main categories: credit history, income, assets, and collateral.

Credit History

How much do you owe? Do you pay your bills on time? Have you ever declared bankruptcy? Credit bureaus take these factors and assign a ‘FICO’ score to you. FICO scores range from 300 to 900. Lenders use these scores in much the same way that college admissions boards use SAT scores. Higher FICO scores mean more loan options and better interest rates. Lower FICO scores spell higher risk. If you do not use credit, you will not get a FICO score. While this limits your choices, you may still qualify for some loan programs. Your mortgage professional can advise you on ways to increase your credit scores, and on how to establish a credit rating so that you can get a score.

Income

Debt-to-income ratio is your total monthly debt divided by your total monthly income. The debt portion includes your housing expense. The higher your expenses are compared to your income, the larger this ratio. Larger ratios indicate greater risk, and higher interest rates.

Assets

Liquid assets are assets that can be quickly turned into cash. Funds in checking and savings accounts and money market funds are very liquid. IRA accounts and stocks and bonds are fairly liquid. Cars and boats are not so liquid. The more liquid assets you have, the better able you are to pay your mortgage if your income is interrupted. More assets translate into less risk. Having lots of liquid assets does not impact the interest rate, but it can compensate for other weak areas. Oddly enough, cash itself can be problematic, because it cannot be ‘traced’. That makes lenders nervous.

Collateral

Loan-to-value is the size of the loan divided by the value of the home. The value of a home is determined by an appraiser, not by the sales price. The more money you invest in a home, the less likely you are to walk away from that debt, leaving the lender holding the bag. Thus, lower loan-to-value presents less risk to the lender, and thereby lower interest rates. When the loan-to-value is greater than 80%, most lenders require mortgage insurance.

HOW DOES IT ALL ADD UP?

This gets tricky. The best way to answer this question is to meet with a mortgage professional that you trust. Speaking with a mortgage professional does not obligate you in any way. Remember, it doesn’t cost to ask. It can cost to not ask.