Applying for a mortgage can be an intimidating process. Let’s take the mystery out of it by exploring just how lenders make the decision to approve you or not and what that approval process looks like.
First, we’ll review the three main factors a lender uses to decide whether you’re safe to lend to and to set their loan terms and interest rates.
Your credit rating
When you apply for a mortgage, the lender will look at your credit score, also known as your credit rating. This is a score that shows how responsible of a borrower you are, based on your personal and financial details.
Your credit score includes factors like:
- How much money you’ve borrowed
- How many credit applications you’ve completed
- Whether or not you make your loan payments on time
Depending on which agency you get your score from, it will be between 0 and 1,000 or 1,200.
If your score is low, lenders may consider you too risky to lend to. But with a higher credit rating, you’re more likely to get approved for a loan—and you may even be able to get lower interest rates.
You can get a free copy of your credit report, which includes your credit score, every three months. There are three credit reporting agencies you can contact for that report:
You may want to contact more than one of these agencies, as they may each have slightly different information. You can also try checking www.creditsmart.org.au/know-your-credit-score/.
If you get a copy of your report and see something that’s wrong or outdated, contact the agency that sent you the report to see if they can fix it. They should do this for free, and you want your rating to be 100% accurate so you have a better chance of getting a good loan.
Your serviceability
Before a lender sets up a mortgage agreement with you, they’ll want to know how much you can afford to borrow. In other words, based on your current finances, how much will you be able to comfortably pay each month? This is known as your serviceability.
To calculate your serviceability, lenders review your monthly income and expenses, as well as your debt and credit history. You should have a fairly good idea of your serviceability if you know your surplus income.
If you need to increase your serviceability, you can start with paying down other sources of debt, especially credit cards and personal loans. You may also want to cut down on your expenses and think about investing or increasing your income in other ways.
Learn more about increasing your surplus income and reducing expenses.
Your borrowing capacity
Knowing your serviceability will help the lender calculate your borrowing capacity, or the maximum amount you can afford to borrow without putting your finances in jeopardy. Your borrowing capacity is usually around 30-40% of your income.
To determine your borrowing capacity, the lender will look at your serviceability (which includes your income and assets), your ability to make money now and moving forward, and any alternative forms of payment or third-party guarantees. Once again, knowing your surplus income will help you estimate how much you can safely borrow.
Getting approved for a mortgage
The mortgage approval process is fairly straightforward, but there are some things you definitely need to know ahead of time. Let’s walk through the steps in order.
- Fill out an application
Obviously, you’ll want to do your research before applying. You may even want to apply with several lenders so you can compare rates. When you’re ready, you can usually apply through a portal on the lender’s website.
- Get a loan estimate
After you fill out an application, the lender should send you a loan estimate form within three business days. This shows the loan amount they’re willing to offer, the type of loan, the interest rate and any other costs associated with the mortgage (such as insurance, closing costs, and property tax).
If you’re comparing different offers, here are a few things to look for:
- Is the interest rate locked? Or subject to change?
- What’s the total cost of the mortgage’s first five years?
- How much of the principal will you have paid off in five years?
- What’s the APR?
- What’s the percent paid in interest?
Most of this information can be found in the comparisons section of your loan estimate.
- Accept the offer
Once you’ve decided on an offer, tell the lender you want to move forward. At this point, the lender may ask you for more documentation. You should also buy homeowner’s insurance if you haven’t yet, as you’ll need this to be approved for the loan.
- Wait for the lender to verify your application
Now, the lender will review your application to make sure everything is correct. They’ll also appraise the property to make sure it matches the price you’re paying for it.
During this part of the process, the best thing you can do is reply quickly to any questions or requests for further documentation. This will keep things moving along. Also, it goes without saying that you’ll want to keep your credit score as high as possible. Don’t take out any new loans and avoid major credit card purchases.
- Get approved
Once all the information in your application has been verified, the lender will assess the risk of lending to you, using your credit rating, your serviceability and borrowing capacity and other factors like the loan-to-value ratio (how the mortgage amount compares to the home’s value). They may ask you for more documentation if they don’t have enough information to make a decision.
- Close
If all goes as planned, the lender will tell you that you’re clear to close. This means you’ve succeeded and they’ve decided to lend to you. Yay!
At least three days before the scheduled closing date, your lender will send you a closing disclosure, which contains the nailed down terms and costs of your mortgage. Take a look and compare it against your loan estimate. If anything has changed, ask your lender to explain why. And make sure you’ve locked in that interest rate.
Finally, you’ll pay closing costs (if you’ve agreed to that), and you’re all set!
