As the big banks are tightening the reins on credit ratings and becoming more literate with our credit histories, qualifying for a great mortgage is getting tougher and tougher by the day. Landing the perfect home loan is more than just the refined interest rate or generous sum amount – it’s more the peace of mind and financial freedom in choosing your perfect home without limitation or restriction.
For most of us, such luxuries are in short supply, and in the real world we are subject to prices that stand like barriers between us and our dream homes.
But there are solutions to this problem. Here’s a short guide to help you ‘groom’ your financial profile and outsmart credit rating systems to turn walls into hurdles and dreams into realities.
Let’s talk about the 3 C’s of lending.
Mortgage lenders place so much weight on individual credit ratings because they represent the risk of investing in you. They help integrate a range of variables into one value that alone represents your financial ability, liquidity and tendency to repay your debts.
These ratings are taken from major credit reporting bureaus and draw information from your payment histories for personal loans, auto loans, mortgages and credit cards, along with other miscellaneous information like foreclosures, bankruptcies or charge offs that you may have been involved with in the past. The trick is to influence the input of this data into each of these variables so that the credit score that banks use to evaluate your credit worthiness upon your application for a loan is pristine from the moment you open your account.
The most important thing to remember is to refrain from late repayments on credit that you have accumulated from everyday spending. When banks see that you have a reputation for repaying loans late and struggle to keep liquid, this could adversely affect your credit score and reduce your trustworthiness as a borrower from a lender’s perspective.
This is all about your financial ability to repay your existing debts. Banks have typically been more willing to offer higher loan amounts and lower interest rates to income earners who have steady salaries in comparison to self employed borrowers, because owning an independent business intrinsically carries higher risk financially than permanent employees.
Another major component of ‘capacity’ is your debt to income ratio (DTI), which calculates what proportion of your income is used to pay off debts. Generally, the higher this ratio, the less liquid your finances are and the riskier it is for banks to lend you money. A typical write-off DTI value where mortgage lenders will pass you over for a loan is higher than 50% (if half your salary is used for debt repayment) as it shows that your spending is disproportionately high relative to your earnings.
Collateral is security for the loan that acts as a safeguard in the case that your finances fall through. Mortgage lenders will be interested in the condition, value, quality, location and type of your property to ensure that its value can mitigate/prevent any losses that might occur in the event that you are unable to repay your loan. Typically, you will be required to undertake a full appraisal to verify the condition and quality of your property by an independent body chosen by the lender.
An important component of ‘collateral’ is the loan to value ratio (LTV), which calculates the ratio of the loan relative to the total purchase price of the property. For example, if you purchase a property at $1,000,000 and you borrow $800,000, the LTV will be 80% (the loan amount contributes to 80% of the total property price). The lower the LTV, the higher the proportion of cash you have relative to the total price, and hence the lower the risk and resulting interest rates you will receive.
We hope this helps for when you next speak to your financial institution or accountant. Here at Titlexchange, we are more than happy to answer any questions you may have in regards to property transfers and conveyancing. Give one of our friendly staff a call today.