When home buyers finally find the home of their dreams and they have chosen the perfect loan program with which to finance their home, the next step is obtaining loan approval. This may be one of the most anxiety inducing and stressful parts of the homeownership process. While loan pre-qualification is not a guarantee by the lender that the loan will be approved, it is certainly a step in the right direction. When it comes time for the loan to be approved, there are three major areas that lenders will use to determine whether or not a home buyer will receive final approval for the home loan. These three areas are: collateral, credit reputation, and capacity.
The Three C's of Loan Approval:
Collateral
Collateral is an area that lenders assess to determine if they should extend credit to a prospective borrower. Collateral consists of things such as the value of the house, the home buyer's down payment, and the type of property the home buyer intends to purchase. The appraised value of the home is important because the lender needs to ensure that the value of the home will support the amount of the loan the home buyer needs to purchase the home. In most cases, the amount of the loan cannot exceed more than 95 percent of either the property's appraised value or the sales price of the home. Not only does the lender take into account the current value of the home but future property values as well.
Capacity
Capacity includes a home buyer's income, debt, and cash reserves. Lenders will require home buyers to produce proof or documentation of their financial capacity. A home buyer's financial capacity provides lenders with an indication of a home buyer's ability to repay the mortgage loan. Lenders may determine a home buyers capacity using a debt-to-income ratio. If a home buyer's mortgage exceeds 29 percent of the home buyer's pre-tax income, the home buyer may not be eligible for the mortgage. Furthermore, lenders prefer that a home buyers housing and non-housing expenses not exceed 41 percent of their total pre-tax income. These preferred percentages could vary by lender.
Credit Reputation
If a home buyer has a history of late payments, judgments, or foreclosures, a lender may deny a home buyer's loan application. Home buyers with these types of credit problems often find it difficult to secure a home loan. It is imperative that prospective home buyers have a good or excellent credit reputation. A home buyer's credit reputation indicates to lenders whether a home buyer will be able and willing to repay a home loan. For those with poor or bad credit, there are steps that can be taken to repair one's credit history. If a loan is denied based on a home buyer's credit reputation, the lender will be obligated to explain the reasons why the loan was not approved.
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