Before You Buy
Mortgage pre-approvals
Factors influencing mortgage pre-approval amount.
Mortgage companies determine how much a person is pre-approved for by considering several factors. These factors help the lender assess the borrower’s ability to repay the loan and the potential risks involved. Here’s a look at some of the key factors considered by mortgage companies when determining the pre-approval amount:
1. Credit score: The borrower’s credit score plays a significant role in the pre-approval process, as it gives the lender an idea of the borrower’s creditworthiness. A higher credit score typically results in a higher pre-approval amount and better loan terms, while a lower credit score may limit the borrower’s options or result in a lower pre-approval amount.
2. Income: The borrower’s income is a crucial factor in determining the pre-approval amount, as it indicates their ability to make monthly mortgage payments. Mortgage companies analyze the borrower’s income from various sources, such as salary, freelance work, rental income, or dividends. The lender will use this information to calculate the borrower’s debt-to-income (DTI) ratio, which is the percentage of their gross monthly income used to pay off debts.
3. Employment history: Having a stable employment history is essential, as it indicates a reliable stream of income. Lenders usually prefer borrowers who have been with their current employer for at least two years, as it demonstrates stability and a lower likelihood of default.
4. Debt-to-income ratio (DTI): The DTI ratio is a significant indicator of a borrower’s ability to repay the loan. Lenders typically require a DTI ratio of no more than 43%, although some may accept ratios up to 50% for well-qualified borrowers. The lower the DTI ratio, the higher the pre-approval amount a borrower may receive.
5. Assets: A borrower’s assets and savings can also be considered when determining the pre-approval amount, as these may be used to cover down payments, closing costs, or financial reserves. Having a larger down payment can potentially increase the pre-approval amount or result in more favorable loan terms.
6. Current debt obligations: Lenders will consider a borrower’s existing debt obligations, such as credit card balances, student loans, and car loans. High levels of existing debt can limit the pre-approval amount because lenders want to ensure borrowers can handle their current debt obligations in addition to the new mortgage.
7. Loan-to-Value Ratio (LTV): The LTV ratio is the percentage of the loan amount in comparison to the appraised value of the property being purchased. Lenders usually prefer an LTV ratio of 80% or lower, which means the borrower must contribute a down payment of at least 20%. Some loan programs allow for higher LTV ratios but may require additional mortgage insurance or higher interest rates.
By analyzing these factors, mortgage companies will determine the maximum pre-approval amount that a borrower can receive. Keep in mind that the pre-approval amount is an estimate and can change depending on changes to the borrower’s financial circumstances, loan terms, or property value.
Down Payment Gift
Important considerations when using a down payment gift in purchasing a home.
When using a down payment gift to purchase a home, there are several important considerations and requirements to keep in mind:
1. Lender requirements: Different mortgage lenders may have specific rules and guidelines for using gift funds as a down payment. It is essential to consult with your lender to understand any restrictions or limitations that may apply.
2. Documentation: Lenders typically require a gift letter from the person giving the gift, stating that the money is indeed a gift and not a loan that needs to be repaid. The gift letter should include the donor’s name, relationship to the buyer, address, contact information, the gift amount, and a statement confirming that the gift is not a loan.
3. Proof of funds: Lenders may also require evidence that the donor has the financial capacity to provide the gift. This can include providing bank statements or other financial documents to show that the funds are available.
4. Seasoning of funds: In some cases, lenders may require that the gifted funds be “seasoned” in the buyer’s account for a certain period (typically 30-60 days) to ensure that the money is genuinely a gift and not borrowed from another source.
5. Tax implications: Gifts above a certain threshold and not between spouses are subject to federal gift taxes in the United States. As of 2021, the annual exclusion for gifts is $15,000 per person per year. If the gift amount exceeds this limit, the donor may be required to file a gift tax return and potentially pay gift taxes.
6. Conforming loans: For conforming loans (those backed by Fannie Mae or Freddie Mac), there may be additional requirements or restrictions on the use of gift funds for down payments, especially if the borrower has a lower credit score or the loan has a higher loan-to-value ratio.
7. FHA and other government-backed loans: The Federal Housing Administration (FHA) and other government-backed loan programs may have specific rules for using gift funds as down payments. Some programs may require a percentage of the down payment to come from the borrower’s own funds, depending on factors like credit scores and debt-to-income ratios.
8. Impact on borrower qualifications: Although a gift can make homeownership more accessible, using a significant amount of gifted funds may impact a borrower’s qualifications for certain loan types or down payment assistance programs.
In conclusion, when using a down payment gift for purchasing a home, it’s important to understand the lender’s requirements, provide proper documentation, and be aware of tax implications and other considerations. Consulting with a mortgage professional, financial advisor, or tax professional to navigate these requirements can help ensure a smooth home-buying process.
