You want to beat the rising cost of homes and increasing interest rates by buying a home soon — but are you going to be able to get a mortgage?
The latest Case-Shiller housing data shows prices have gone up a little over 12% in just a year, and the National Association of Realtors’ latest numbers are even more optimistic, showing a nearly 14% year-over-year increase. Meanwhile, the rate for a 30-year mortgage has shot up by more than a percentage point in the past three months and is now hovering a bit over 4.5%.
Of course, those home prices haven’t rebounded to anything close to their pre-recession peak in most markets, and interest rates are still low by historical standards, so if you’re thinking of buying a home sometime in the future, doing so sooner rather than later might make economic sense.
The “but” here is that getting a mortgage, though easier than it was a couple of years ago, is still a challenge for many Americans. Data from the Ellie Mae Origination Insight Report shows that in July, the average mortgage applicant approved for a conventional loan had a FICO score of 759. Meanwhile, even the ones who applied and were rejected had FICO scores averaging 726. This is actually an improvement over last year, when borrowers had an average FICO score of 763. But the days of waltzing into a bank with a 640 FICO score and getting pre-approved on the spot are over.
As a result, about a third of home purchases are being made by people — investors, foreign buyers, or wealthy Americans — who just plunk down cash for a house. That’s great if you happen to have $213,500 — the average amount of an existing-home sale in July, according to the National Association of Realtors — laying around, but if you don’t, here are some tips on how to give yourself the best shot at getting a mortgage.
Improve your credit score. “Credit is getting a bit looser recently, but even people with high credit scores are being denied loans,” says Jed Kolko, economist at real estate site Trulia.com, an observation that’s borne out by that Ellie Mae data. Order your credit report from annualcreditreport.com so you know what you’re dealing with, especially if you’ve never checked your credit before. Getting any mistakes corrected should be your first order of business. After that, look to lower your utilization ratio — the percentage of your available credit you’ve used at any given time. The typical rule of thumb is to keep it under 30%, but lower is better.
Don’t open any new cards. This is old advice, but it’s even more important now that lenders have such high expectations. You might think adding a new credit card would help your utilization ratio, but applying for credit shortly before or during the application process pulls down your credit score. It could be only a few points, but that could affect your rate and even whether you’ll be approved for a loan at all.
Here’s the exception to this rule: If you’re new to the world of credit, apply for the best credit card you think you can get six months or more before you plan to begin the mortgage application process. Since you’ll ding your credit score a little bit, you want to space it out so you get the benefit that credit has on your utilization ratio without taking the hit for opening the new card.
Put more money down. “Zero-down loans are rare nowadays compared with the bubble years,” Kolko says. That said, don’t despair if you don’t have 20% of the purchase price saved up.
“Lenders are more willing to work with consumers these days even if someone doesn’t have a perfect score,” says Ken Lin, CEO of CreditKarma.com. “For example, if you have a little lower credit score, but can put down 20% or maybe you only have 5% to put down but a great credit score, you can still qualify for a mortgage,” he says.
Pay down your debt. “Because home prices are rising faster than incomes, and also because mortgage rates are rising, the debt-to-income ratio will become a hurdle for more buyers,” Kolko warns. He says monthly payments have risen 20% in just a year thanks to the combination of rising home prices and interest rates.
“When you think about just your housing costs, your debt load— which includes taxes and homeowners insurance — should be 28% or less of your gross monthly income,” Lin advises. But once you add debt from credit cards and auto and student loans, the amount shouldn’t be higher than 36% of your income, he says. The Ellie Mae data shows that successful mortgage borrowers have an average housing debt-to-income ratio that’s even lower, at 24%.
Give yourself more time than you think you need. Improving your credit score and socking away a down payment takes time. Lin suggests giving yourself a six-month head start. In theory, credit report errors can be cleared up in 30 days or less, but an investigation last year found that getting even simple stuff fixed can drag on for months in some cases.