5 Things Lenders Look For in a Loan Application

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Banks and lenders take a risk whenever they approve someone for a mortgage loan. There's no guarantee, after all, that the borrower will pay the loan back in time.

But there are five key financial factors that lenders look for when approving loan applications. And if you have these key financial positives, your odds of qualifying for a mortgage loan will increase dramatically.

1. A FICO Score of 740 or Higher

Your three-digit FICO credit score certainly ranks as one of the most important numbers for loan applicants. This number tells lenders how well you've managed your credit in the past.

Plenty goes into your credit score. But here are the basics: Late or missed payments on credit cards, auto loans, student loans, and other forms of revolving credit linger on your three credit reports — you have one maintained by each of the national credit bureaus of Experian, Equifax, and TransUnion — for seven years. And they'll cause your score to drop, often by 100 points. Bankruptcy filings and foreclosures will remain on your credit report for seven to 10 years, and will cause even more damage.

So if you want a strong FICO credit score, pay your bills on time and pay down your credit card debt. Lenders today consider a FICO score of 740 or higher to be a top-tier score. If your score is too much lower, you'll struggle to qualify for a mortgage loan. And when you do, you'll pay a higher interest rate.

2. A Debt-to-Income Ratio of 43% or Lower

Credit scores get much of the press, but your debt-to-income ratio is another key number when applying for a mortgage. Lenders today prefer working with borrowers whose total monthly debts, including their estimated monthly mortgage payments, equal no more than 43% of their gross monthly income.

If your debt-to-income ratio is too high, you'll again struggle to qualify for a mortgage loan. Lenders will worry that you won't be able to afford a monthly mortgage payment in addition to your other debts.

3. A Credit Report Free of Negative Judgments

Lenders get nervous when they see bankruptcies or foreclosures on your credit reports. They worry that you'll again run into financial trouble and not be able to make your monthly mortgage payments.

The big challenge is that these negative judgments remain on your credit reports for a long time. A foreclosure remains on your reports for seven years, as does a Chapter 13 bankruptcy filing. A Chapter 7 bankruptcy filing doesn't fall off your reports for 10 years. And while the impact on your FICO credit score lessens over time, lenders can still see — and stress over — these negative judgments.

4. A Two-Year Employment History in Your Field

Lenders want to be as certain as possible that your income won't disappear. After all, if that happens, the odds that you'll stop making your mortgage payments will soar. That's why lenders prefer working with borrowers who can show that they've worked in their field for at least two consecutive years.

It is possible to get a mortgage loan without this. But having a stronger work history can only help boost your odds of qualifying for a mortgage.

5. Savings

Taking out a mortgage isn't inexpensive. You'll need thousands of dollars to cover your loan's closing costs. And you'll need even more for a down payment. A down payment of 5% on a mortgage loan of $200,000 comes out to a hefty $10,000, for example.

But being able to afford these upfront costs is only part of the puzzle. Lenders also want you to have savings in reserve. That way, if your regular monthly income stream dries up because of a job loss or pay cut, you'll have enough money in savings to keep paying your mortgage while you rebuild that income.

How much savings you'll need varies by lender. Most lenders, though, will require you to have from two to six months' worth of mortgage payments — including the money you are paying for property taxes and insurance each month — saved up.

Would you qualify for a mortgage according to these guidelines?