How Lenders Determine Your Borrowing Ability
If you are thinking about buying a home, one of the first things you should do is go to a lender to get pre-approved. This will determine how much money you can borrow on a mortgage. This will also help you filter your home search by sale price, which will narrow your choices within your financing range. Lenders evaluate your borrowing ability by looking at credit, capacity, and collateral.
Credit or FICO Score: The first item a lender will review is your credit profile, also known as your credit score or FICO score. This is where all the decisions you’ve made in the past regarding will be reflected, such as: how much debt you have outstanding, how much debt you have outstanding as a percentage of open credit accounts, how much debt you have in the different types of credit accounts (credit cards, car loans, school loans, etc.), and how well you’ve paid your bills over the years. Lenders used to allow much lower credit scores for borrowing purposes, but they’ve gone up the past few years. The lower your score, the higher your interest rate and points on your mortgage loan.
Capacity or Income: If you pass the FICO score test and the lender says you are creditworthy, the next item you will be evaluated for is capacity, which means that based on the lender’s allowed maximum percentage debt to your gross income, minus all of your other debt payments, how much do you have available for a housing payment?
Collateral or the Property: If you’ve got the credit, and the capacity, you only need one more piece and that’s the collateral. This is the easiest part. You will pay the bank and they will order an independent appraiser to determine a market value of the property.