What do Lenders Use to Decide How Much to Lend You?

If you are thinking about buying a home, but have no clue how much mortgage you might qualify to receive, you have a lot of work ahead of you. Even if you have a number in your mind, your mortgage lender might say otherwise.

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So what do lenders use to decide how much to lend you? Keep reading to find out.

The Program’s Loan Limits

First, each loan program has limits. For example, conforming loans backed by Fannie Mae or Freddie Mac have a limit of $484,350 in most areas this year. The exception is those high-cost counties where they have increased the limit for those specific counties. FHA loans have limits based on the average cost of a home in each county as well.

The lender must stick to these limits in order to process your loan. If the lender has their own program that isn’t backed by Fannie Mae, Freddie Mac, or any of the government entities, they can then set their own limits. Otherwise, they are bound by the same loan limits that every other lender must use.

Your Debt Ratio

Next, lenders have to determine how much you can afford. Now, this isn’t a number that you come up with on your own that you think you can afford. The amount you can afford is based on your income and your current debts. It’s called your debt ratio.

Lenders compare your total monthly debts to your gross monthly income to come up with your debt ratio. Each loan program has their own maximum debt ratios that they allow; they are as follows:

  • Conventional loans – 28% housing ratio and 36% total debt ratio
  • FHA loans – 31% housing ratio and 41% total debt ratio
  • VA loans – 41% total debt ratio
  • USDA loans – 29% housing ratio and 41% total debt ratio

As you can see, except for the conventional loans, you can typically have a total debt ratio of at least 41% and get a loan. The total debt ratio includes all of your minimum credit card payments, installment loan payments, student loan payments, and the new potential mortgage payment. Remember, lenders use your gross monthly income for this calculation – this is your income before taxes.

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Other Compensating Factors

While your debt ratio and the program’s guidelines play the largest role in how much you can borrow, other factors include your credit score and LTV or loan-to-value ratio.

Your credit score lets a lender know whether or not you are a good financial risk. If you have a high credit score, you show lenders that you pay your bills on time and use your credit wisely. If you have a low credit score, it lets lenders know that you may not be very financially responsible or that you don’t use your credit wisely. The credit score can be the driving factor in a lender’s decision. Even if your loan amount fits within your debt ratio and the program’s guidelines, your credit score can ruin your chances.

The amount you put down on the home can also have an effect on your loan amount. Lenders like to see borrowers put their own money into the investment. This helps reassure lenders that you will make your payments on time in order to ensure a lower risk of default. If you put little money down and your debt ratio is close to the maximum, lenders could look at you as a high-risk borrower. While they may give you the loan amount that you need, it could come with a higher interest rate. Some lenders may lower your loan amount, though, depending on how high your risk of default may be.

Lenders basically look at the big picture when deciding how much loan you can afford. The program limits aren’t negotiable, though, so you have to stick within those guidelines. Your debt ratio, credit score, and down payment do play a vital role in the process, though. Because each lender may have their own rules and regulations, it pays to shop around to find the lender that will give you the loan amount that you need.

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