Mortgage lenders consider many factors when deciding whether to extend a loan and the interest rate you will pay for this loan. Your credit worthiness is determined by three main components: your credit history, your income, and the loan-to-value ratio.
Credit History
Credit bureaus collect information about the amount of debt you have and whether you pay your bills on time. They compile this information into a file called a credit report, and then boil all this down to a number. That number is your credit score. It is also often referred to as a FICO score, after Fair Isaac Corp., the company that pioneered credit scoring.
This article describes how to obtain your credit report and understand it. You can buy your FICO score directly from Fair Isaac. However, federal law entitles you to one free credit report per year. The report and the score may be bundled together or provided separately.
Your credit report contains...
- Identifying information, such as your name, address, and Social Security number.
- Credit history, such as when you opened your accounts, how much you owe, your credit limits, whether accounts have been closed and whether your payments have been made on time.
- Public records, such as whether you have any bankruptcies, foreclosures, liens, repossessions, or legal judgements against you (including failure to pay child support or taxes).
- List of recent credit inquiries.
Income
Lenders want to know your annual income, and how long you've been at your job, as well as how long you have been working in your particular field. They will look at your total debt-to-income ratio: How much of your monthly income goes toward paying the mortgage, credit card bills, car payment, and other obligations, including payments on the equity debt for which you are applying. Most lenders want to keep that ratio under 36 percent.
Be prepared to show your lender proof of income, such as W-2s, tax returns and other earning statements.
Loan to Value Ratio (LTV)
This is the ratio between what you owe on your house and what it's worth. If your house is worth $100,000 and you still owe $80,000, your loan-to-value ratio is 80 percent. When you bought the house, calculating the LTV was straightforward: the mortgage amount divided by the home's price.
It's more complex when you get a home equity product, becuase the home's value has probably changed since you bought it. The lender will get an appraisal of the home's current fair market value. Then it will add the current mortgage balance to the size of the equity loan or credit line that you want, and divide that by the home's current value. The result is the new LTV ratio.
Traditionally, equity lenders want to keep your total loan-to-value at 90 percent or less. So, for example, if you owe $100,000 on a house that is now valued at $200,000, you could potentially get an equity loan up to $80,000. A loan that size would increase your total housing debt to $160,000, or 90% of the home's value.