Lenders look at your income, expenses and credit score, among other things, before approving you for a mortgage. The law requires lenders to carry out all reasonable checks to ensure you’re not lent money you cannot afford to repay.
By understanding how much you earn and how you manage your money, lenders can get a fair idea of your repayment capacity and whether the money you’re borrowing will be difficult for you to repay. So, if you earn a high income but spend most of your money on maintaining your lifestyle or repaying other debts, your likelihood of getting approved for a mortgage could be low. On the other hand, if you manage to save regularly despite a modest salary and don’t have any onerous debts on your file, your chances of mortgage approval are high.
Even though all lenders have slightly different lending criteria, they generally employ similar guidelines when assessing your mortgage application. Knowing how your money habits affect your mortgage application can help you assess your suitability for mortgage approval and work on any areas that will help you qualify.
Top things lenders consider when reviewing your mortgage application
Understanding what lenders look for when approving a mortgage can help you work on those areas and improve your chances of approval. Here are some common factors considered by all lenders when reviewing a mortgage application.
- Employment and income
How much money you earn and how you earn are important factors determining your suitability for a home loan. Lenders prefer to work with individuals who earn a regular, consistent salary, as proven by several consecutive pay slips. If you earn any regular bonuses, commissions, or overtime payments, they may or may not be considered a part of your annual income while calculating your mortgage eligibility. Even lenders who do consider such payments as part of your income will heavily discount them.
If you’re not in a regular job, which could mean you’re self-employed or run a business, you might find it challenging to qualify for a traditional home loan due to a lack of pay slips to prove consistent income. A low-doc loan is usually a more suitable option in such situations to get your foot on the property ladder.
Apart from how you earn and what you earn, lenders are also interested in your employment history. Your chances of approval are higher if you’ve been working at the same place for a year or more. A consistent employment record indicates stability, and lenders view you as a lesser risk. However, if you constantly hop between jobs, it could be a red flag for lenders because you won’t have a consistent employment record or stable income to show.
- Spending habits
When you apply for a home loan, lenders will most likely ask you for your bank and credit statements for up to six months to get an insight into your spending patterns. They’ll usually want to determine how much you spend on living expenses each month, as well as on entertainment and other things. They might also check for regular bank payments or transfers that could indicate debt. By reviewing all these things, lenders want to establish if you can manage your expenses within your earnings or if you are living beyond your income, which could adversely impact your mortgage application.
- Credit score
Your credit score is like your financial report card – a number that signifies your relationship with money and how prompt you’ve been with your repayments in the past. It is based on your payment history and helps lenders analyse how likely you are to default on your repayments.
In general, a higher credit score indicates high creditworthiness, and lenders are more likely to approve your loan and even offer you interest rate discounts if you possess a good credit score. A lower credit score, on the other hand, could indicate past financial problems, which can impact your mortgage application adversely.
If you’re planning to apply for a mortgage, make sure to check your credit score to know where you stand. If your credit score is low, you can ask for a free copy of your credit report from each of the three credit bureaus to check for any mistakes that could be bringing down your credit score. If your score is low for any other reason, it could help to wait a few months and work on improving your credit score before applying for a home loan again.
- Deposit and genuine savings
If you plan to buy a house, one of the first things you need to do is start saving money regularly. Most lenders require you to put down a 20% deposit on a house to get approved for a home loan. However, some lenders allow you to borrow with a lower deposit if you agree to pay for Lenders Mortgage Insurance to cover their lending risk. Still, you cannot borrow the property’s full purchase price, and you’ll need at least 5% of the property price in genuine savings to qualify with most lenders.
Saving money regularly helps you in two ways. It counts towards your deposit and shows lenders you are good at managing your money, which gives them confidence that you’ll be able to afford your home loan repayments.
- Debt-to-Income ratio
When calculating your repayment capacity, lenders also consider any debts you might have (such as a car loan, education loan, credit cards, and even BNPL debt). They typically add up all your loans to calculate your debt-to-income (DTI) ratio, which is your debt relative to your overall income.
DTI ratio is calculated by dividing your total debts and liabilities by your gross income. For instance, if you have total debts worth $450,000 and earn $150,000 annually, your DTI ratio would be 3. While this is a safe figure, if your DTI is 6 or more, lenders might consider it risky to approve your home loan. That’s because they believe a significant percentage of your income is applied towards servicing your loan, and you’re likely to struggle with your repayments if there’s a sudden change in your financial circumstances.
Top tip: While calculating your debts and liabilities, lenders use the full credit limit on your card irrespective of how much money you owe on it. It could thus help to reduce your credit limit to improve your DTI.
What to do if your home loan application is declined?
If your home loan application is declined, it’s worth finding out the cause and working on improving that area before applying again. Making too many home loan applications close to each other can hurt your credit score and make you look hungry for credit, further reducing your chances of getting approved for a loan.
You may also want to revisit your credit score and check your finances to find out what went wrong. If you need help, you could consider speaking to a mortgage broker to better understand your situation and seek help when you re-apply for a home loan.
