What Do Mortgage Lenders Look For in a Borrower?

The mortgage loan approval process can be a stressful experience, but if you know what to expect, it doesn’t have to be. Some buyers may run into unexpected obstacles, but you can save yourself a headache as long as you know in advance about potential issues and what mortgage lenders want to see from their borrowers.

First Things First: Identify a Mortgage Company

One of the first steps on the home-buying journey is typically researching different mortgage lenders and rates and going through the pre-approval application process with a lender that is likely to give you the best rate and loan terms for your situation. While this process isn’t the same as going through the formal mortgage application process, it will give you an idea of how big of a loan and the type of rate you may be eligible to receive.

Once you’re pre-approved for a mortgage loan, you will then receive a letter from the lender with your pre-approved mortgage limit and rate. You can then share this letter with any potential sellers when making an offer on a property.

Why Should You Start with Mortgage Pre-approval?

A mortgage pre-approval letter can be a valuable tool when you’re looking to make an offer on a home. If two buyers are making an offer on a home and only one of them has a mortgage pre-approval letter, the seller may take the pre-approved buyer’s offer more seriously.

The pre-approval process also allows you to have a “practice run,” as it’s similar in ways to the mortgage application process. This will give you a sense of what to expect when you officially apply for a mortgage and the types of financial documents you will need to provide. It can also provide insight as to whether you need to reset your expectations in terms of the type of property you can afford.

What Do Mortgage Lenders Look For in a Borrower?

Borrowing standards differ from lender to lender, but generally, when reviewing a mortgage application, a lender will determine whether a potential borrower will be able to keep up with their mortgage payments.

As you’re researching different lenders and searching for properties, you should begin gathering documents and reviewing your finances so you’re ready to submit an application as soon as necessary. Let’s look at 5 types of information your potential lender will review.

1. Bank Account and Employment Documents

At a minimum, you should expect to provide two recent paystubs, your two most recent W2s, two months’ worth of bank statements, your most recent tax return, and copies of any existing mortgage statements and property tax bills. If you own an LLC, are self-employed, or work as a contractor, you will likely be asked to provide business tax returns for the two most recent years, 1099s, and other relevant documents such as K1s.

2. Credit Score

Your lender considers two key pieces of information from your credit report. The first is your credit or FICO score. This is a score that ranges between 300 and 850 and summarizes your debt repayment history. A higher credit score will typically translate into a better mortgage rate, so it’s important to review your credit history for any errors before applying for pre-approval or a mortgage.

Now you know that a lender will look at your credit score. But did you know you may have more than one score? Mortgage lenders often consider an average of your credit scores from the three major credit bureaus — TransUnion, Equifax, and Experian.

3. Credit History

Lenders will also look at your credit history to ensure you have a record of making on-time payments. A history of missed or late payments can negatively impact your mortgage application, so it's important to have a good track record of paying bills on time if you want to purchase a home.

4. Debt-to-Income Ratio

When reviewing your credit history, your lender will also look at your monthly debt payments compared to your income to help determine how much money you will have each month to service your new mortgage and any existing debt. By comparing your monthly debt payments against your monthly income, lenders can determine your DTI, or debt-to-income ratio. A higher DTI can make it more difficult to qualify for a loan and increase the interest rates you will face. Some lenders may require a lower DTI than others, but max thresholds have been known to range from 36% to 43%, depending on the lender and other factors in your credit profile.

5. Your Assets

Lenders will review your assets to determine that you have the cash to cover your down payment, closing costs, and at least some of the mortgage payments to come. Assets can include your checking and savings account balances, or liquid assets, and illiquid assets like stocks, bonds, mutual funds, and retirement accounts. Lenders typically like to see 3–6 months worth of mortgage payments in reserves, which provides coverage in the event of a job loss or an unexpected drop in income.

What Does a Lender Need to See After You Make an Offer?

Once a seller has accepted your offer, it’s time for the actual mortgage loan application process to begin. Mortgage approval is similar to pre-approval except the underwriting process will be more intensive. There are additional steps regarding the home you’re purchasing, including an inspection and appraisal.

Home Inspection

You’ll need to schedule a home inspection after your initial offer has been accepted. A home inspector will examine the property to determine whether there is any damage or other issues that will require repairs and intervention. This will allow you to adjust your offer or even pull out entirely if significant problems with the property were not disclosed.

Because your lender is going to use the home as collateral to be seized if you don’t make your monthly mortgage payments, they have an interest in only approving mortgages for properties that are actually worth the amount of the loan.

To that end…

Home Appraisal

Because mortgage lenders want to be certain the property for which they are providing the mortgage is actually worth the loan amount, they will require an appraisal as part of the approval process. The appraisal will tell the lender how much the home is worth to ensure the borrower isn’t taking on debt beyond the home’s value, which can be risky.

In a nutshell: While you may find your dream house and love it so much you’re willing to pay whatever it takes, your loan officer may not be as sentimental.

What Do Lenders Need to See During the Closing Process?

Once your home loan has been approved, you will then move on to the final phases, which involves signing a lot of documents and paying a lot of money in closing costs. Prior to the loan clearing, your lender or mortgage broker may ask you to resubmit additional financial documents and confirm that you have enough cash on hand to close the sale.

Be sure you’ve put aside a significant amount of money to cover your closing costs and down payment. According to the CFPB, this could be up to 5% and 20% of the total cost of the home, respectively, though there is a lot of variance. You will most likely need to show proof of how you plan to cover these expenses before the official home purchase takes place. When the closing is complete, you will officially own your new home.

What Can Keep You from Mortgage Approval?

While this road map should give you a good sense of how to navigate the mortgage approval process, unexpected obstacles can arise.

Income Changes

Big changes in sources of income, such as a job loss or change can be a red flag for lenders. Be prepared to explain your employment history if necessary.

Credit History Issues

A lack of credit history, not just a low credit score, can also cause problems. You may be able to raise your credit score by opening a line of credit, like a credit card, and paying your bill in full each month so you don’t carry over a balance. There are also ways to report other types of bills you are already paying on time through services like Experian Boost.

As long as you make consistent on-time payments, you should establish good credit that will be vital for becoming a homeowner.

Property Issues

It’s not just your personal financial situation and history that can throw a wrench into things, however. There could be an issue with the property you want to buy.

For example, lenders may require additional information for some types of properties. Before approving a mortgage for a condo, the lender may ask for documentation from the condo association, such as financial statements and bylaws.

A troublesome inspection can also lead to unfortunate surprises that can derail approval and closing.

The Bottom Line

Lenders want to be sure that their borrowers are reliable and the properties they finance are worth the investment. Knowing what to expect before getting too far along on your journey with a real estate agent can help the process go more smoothly when you are ready to make an offer.