What Do Mortgage Lenders Look for in a Borrower?

For the past few years, Americans have been clamoring to make their homeownership dreams come true, resulting in steep competition for a house as soon as the for-sale sign hits the lawn. In order to make that dream a reality, most homebuyers will rely on a mortgage to finance the purchase.

But what, exactly, do mortgage lenders look for in a borrower?

In short, they’re looking for someone who is likely to repay the loan. Put another way, they want to find a borrower who has the lowest possible risk of defaulting. If a lender deems you to be a low-risk borrower, then you are more likely to have your mortgage application approved. You’re also more likely to qualify for better terms, such as a lower interest rate and higher available loan amount.

If a lender deems you to be a high-risk borrower, however, you may only qualify for a small loan with a higher interest rate — or your application may be denied outright. So how do lenders determine how much risk you pose? Here’s what mortgage lenders look for when they evaluate the risk of different borrowers who apply for a mortgage.

What do mortgage lenders look for?

1. Your credit score

Your credit score is a three-digit number that quickly communicates a lot of information about you as a borrower to your potential lenders. Generally, the higher your score, the more creditworthy (i.e., less risky a borrower) you’re deemed to be. A good credit score will typically fall somewhere between 670 and 739; a very good score falls between 740 and 799; and an excellent score is anything above 800.

The problem with credit scores is that they don’t communicate specific information to the lender. While they’re a great tool to quickly evaluate a borrower, your lender is ultimately going to access your full credit report to make a truly informed decision about you. In fact, your full credit report is where many of the factors discussed below will come from.

Still, if you know you’re going to be applying for a loan soon, it helps to take steps as soon as possible to boost your credit score.

2. Your payment history

Your payment history is exactly what it sounds like: A record of your history making payments on debts such as credit cards, auto loans, student loans, etc. — really, anything that would appear in your credit report.

Lenders prefer borrowers who have a long history of making on-time payments. The fewer late payments you have on your credit report, the more appealing you’ll be to a mortgage lender. It should be no surprise, then, that your payment history makes up 35 percent of your total credit score — more than any other individual factor.

3. Your income and employment history

Most mortgages are repaid over the course of 15 to 30 years. As such, mortgage lenders need to be certain that their borrowers will have a stable source of income to pay back the loan over this time.

First, when you apply for a mortgage, the lender will contact your employer to verify that you are in fact an employee. But beyond this, they’ll review your employment history for the past two to three years, looking for periods of unemployment or low income. Simply put, the more consistent your employment history, and the fewer unexplained gaps you have, the less risky you’ll appear to the lender.

4. Your debt-to-income ratio

Your debt-to-income ratio (DTI) is a number that shows how much debt you carry compared with your income. So if your gross monthly income is $5,000 and you spend $1,000 of that paying off debts (e.g., minimum credit card payments, student loans, car payments and even child support), then your DTI is 20 percent.

Lenders use the number to understand whether you are carrying an unsustainable level of debt. The higher your debt-to-income ratio, the more difficult it may be for you to meet your obligations each month. Generally speaking, most mortgage lenders want to see borrowers with a DTI of less than 36 percent, including your monthly mortgage payment. Within that, they also want to see that housing expenses specifically (mortgage, homeowners insurance and property taxes) do not exceed 28 percent of your total gross monthly income.

5. Your assets

In addition to considering your employment history and income, the lender will also consider whether you have any additional assets that you could convert into cash. That’s because these assets provide you with a potential source of cash flow. In the event you were to lose your job, having access to cash means that you could continue to make your mortgage payments on time.

Cash in a savings account or money market account, stocks and bonds held in a non-retirement brokerage account, and other assets like collectibles or property could all be considered by a lender. Generally speaking, the more assets you have to your name, the less risky a borrower you appear to be.

6. Your down payment

The size of your down payment matters to lenders for a few reasons. The larger the down payment, the smaller your mortgage will be and the lower your loan-to-value ratio (the percentage of your home’s value that you’re financing) will be, which translates into less risk for the lender. A smaller mortgage will also translate into a lower DTI for you, which will make you more appealing as a borrower.

In addition, the more you put down on a home, the more equity you’re giving yourself in your home upfront. If you’re getting a conventional loan and you’re putting less than 20 percent down, the lender will likely charge you private mortgage insurance to cover its risk.

Beyond this, the higher your down payment, the more you’re proving to the lender that you are willing to invest in your home. And the more invested you are personally, the less likely you are to default.