These Are the 3 Most Important Numbers When Applying for a Mortgage
If you have been thinking about buying or refinancing a home, there are 3 important numbers to consider - your credit score, debt-to-income ratio (DTI), and loan-to-value ratio (LTV). These numbers can determine your ability to qualify for a mortgage and how much it will cost you. Here you will find a quick explanation of what each of them is and why it matters.
What Is a Credit Score?
You have probably heard about this one before. A credit score, or a credit rating, is a three-digit number, that will tell your lender how likely is it that you will pay the credit back. This number is usually between 300 and 850. The higher the number, the greater the chances you will have for credit, at the best rates. This number is measured by credit bureaus - Equifax, Experian, and TransUnion, based on a person’s payment history, credit limit usage, debts they have, etc.
Once you give them permission, lenders can request your credit score from one or all of the credit bureaus. There are two types of credit checks - a 'soft' check and a 'hard' check. A soft check is done in the beginning of a mortgage process, and it will have no impact on your credit score. However, a hard check will affect your credit rating, and too many hard checks during a small period of time can reduce your chances to get approved for credit in the future.
Why Is It Important?
Not only lenders offer better interest rates for persons with a higher credit score, but most lenders also have a minimum credit score for their loans. Do a soft check yourself and see how eligible you are for credit without actually applying. You can do numerous soft checks - they will have no impact on your credit score and leave no trace on your credit record. If you have enough time, try improving your rating to help you save on your mortgage.
What Is a Loan-to-value Ratio (LTV)?
A loan-to-value ratio (LTV) is a financial term that shows how much equity you have in your home. It is a percent you need to pay in order to fully own your home. The higher the number, the riskier the loan is for a lender.
It is easy to calculate your LTV by yourself. If you borrow $180,000 to purchase a house worth $200,000, your LTV ratio is $180,000/$200,000, or 90%.
Why Is It Important?
Lenders usually have a maximum LTV (a down payment minimum) for a home purchase. Exact LTV maximum will depend on several factors, such as loan amount, property type, are you a first-time homebuyer, etc. When your lender's limit is greater than your LTV, you will either have to find a property with a lower price or increase your down payment.
If your down payment is less than 20% (meaning your LTV is 80% or higher), your lender may require mortgage insurance. Once your LTV reaches 78%, mortgage insurance for conventional, non-government loans cancels automatically (however, mortgage insurance for government loans like FHA cannot be canceled). If you have met your lender’s criteria, your mortgage insurance can be canceled slightly earlier.
For a cash-out refinance, lenders will usually require that your LTV stays at or below 80%.
What Is a Debt-to-income Ratio (DTI)?
A debt-to-income ratio (DTI) is a financial term that shows how much you can afford to pay for a mortgage each month. All your existing monthly debt payments (for a car or a student loans, credit card bills, etc.), including your future mortgage payment, are calculated together and divided by your gross monthly income (money you earn before taxes).
Why Is It Important?
Lenders have a DTI limit, so they make sure that you can afford to pay your mortgage. A high DTI is the most important reason why your mortgage applications might be rejected. Take some time to lower your DTI before starting the mortgage process.