Securing a mortgage is a significant step towards owning a home, but the process can be complex and competitive.
Lenders take various factors into account before approving your mortgage application, and understanding what they look for can help you improve your chances of getting approved.
In this article, we’ll highlight the top 5 factors lenders consider when approving your mortgage. If you’re unsure how to avoid LMI (Lenders Mortgage Insurance), this guide will help clarify the key elements that can influence your mortgage approval.
1. Your Credit Score
One of the most critical factors that lenders consider when approving a mortgage is your credit score. This number reflects your creditworthiness and shows lenders how reliably you have managed debt in the past.
How Credit Scores Affect Mortgage Approval
Lenders use credit scores to assess the risk of lending to you. A higher credit score demonstrates that you have been responsible with managing debt and are likely to make timely mortgage repayments.
Conversely, a lower credit score may indicate that you have had financial difficulties in the past, making lenders hesitant to approve your application.
How to Improve Your Credit Score
- Check your credit report: Request a copy of your credit report and ensure that there are no errors. If you spot any inaccuracies, dispute them with the credit reporting agency.
- Pay your bills on time: Consistently making timely payments can help improve your credit score over time.
- Reduce outstanding debts: Pay off high-interest debts first and avoid taking on new credit before applying for a mortgage.
While a good credit score is not the only factor, it plays a major role in your lender’s decision-making process. A higher score may even result in more favourable loan terms.
2. Your Income and Employment Status
Lenders want to ensure that you have a reliable source of income to repay your mortgage. This is why your income and employment status are key factors in the mortgage approval process.
How Lenders Assess Your Income
Lenders will typically require proof of income, which can include pay slips, tax returns, or bank statements.
Your income level will help the lender determine how much you can afford to borrow. They will also assess the stability of your income by considering your employment history.
If you are self-employed, lenders may require more documentation, such as your business’s financial statements or tax returns over the past few years, to gauge your income stability.
What Lenders Look for in Employment Status
- Permanent vs. casual employment: Permanent employees are generally seen as less risky because they have a stable income. Casual workers or those with a temporary contract may be considered higher risk.
- Job history: A stable job history, ideally with the same employer for a few years, gives lenders confidence that your income is predictable.
- Self-employment: If you’re self-employed, lenders will scrutinise your business’s financial performance. Self-employed applicants may need to provide extra documentation, such as a profit and loss statement, to prove their income consistency.
If you’re unsure about how to strengthen your financial profile, it’s worth talking to a financial advisor to find ways to boost your chances of approval.
3. Your Deposit and Loan-to-Value Ratio (LVR)
The deposit you can provide when purchasing a property plays a major role in the lender’s decision to approve your mortgage. The Loan-to-Value Ratio (LVR) is the ratio between the loan amount you need and the appraised value of the property.
How LVR Affects Mortgage Approval
The LVR is a key factor in determining your mortgage terms. A higher LVR indicates that you are borrowing a larger percentage of the property’s value, which poses a higher risk to the lender.
Most lenders prefer an LVR of 80% or less, meaning that you provide a 20% deposit or more. If your LVR is higher than 80%, you may be required to pay Lenders Mortgage Insurance (LMI), which protects the lender if you default on the loan.
Ways to Reduce Your LVR
- Save a larger deposit: The more you can contribute towards the deposit, the lower your LVR will be. This reduces the risk to the lender.
- Consider a guarantor: Some lenders allow you to use a family member’s property as security for the loan, reducing your LVR.
- First Home Buyer Schemes: Certain government schemes, such as the First Home Loan Deposit Scheme, can help reduce the deposit required, allowing you to borrow with a lower deposit.
The more you can reduce your LVR, the more likely you are to avoid LMI and secure a more competitive interest rate.
4. Your Debt-to-Income Ratio (DTI)
Lenders use the Debt-to-Income (DTI) ratio to assess how much of your income is already committed to servicing existing debts, including credit cards, personal loans, and car loans.
A high DTI suggests that you may struggle to meet additional financial commitments, making you a higher risk for the lender.
How DTI Affects Your Mortgage Application
Lenders calculate your DTI by dividing your total monthly debt repayments by your gross monthly income.
For example, if you earn $5,000 per month and your debt repayments total $1,500, your DTI ratio is 30%. Generally, lenders prefer a DTI ratio below 40%, although some may accept higher ratios depending on the loan amount and other factors.
A lower DTI indicates that you have more disposable income, which reassures the lender that you can handle your mortgage repayments without financial strain.
Ways to Improve Your DTI
- Pay off existing debts: Prioritise paying down high-interest debt like credit cards before applying for a mortgage.
- Increase your income: A higher income can lower your DTI ratio, making you more appealing to lenders.
- Avoid taking on new debt: Don’t apply for new loans or credit cards in the months leading up to your mortgage application.
Managing your DTI ratio can significantly improve your chances of mortgage approval and help you secure better loan terms.
5. The Property You Are Purchasing
The property itself is another key factor that lenders consider when approving your mortgage. Lenders will assess the value of the property you want to purchase and whether it represents a good investment.
Property Appraisal
Before approving your loan, the lender will arrange for an independent property valuation to ensure that the property is worth the amount you’re borrowing. If the valuation comes in lower than expected, the lender may reduce the loan amount or deny the application altogether.
Property Type and Location
Lenders also consider the type and location of the property. Some properties, such as apartments in high-rise buildings or properties in rural areas, may pose a higher risk to the lender, especially if the market conditions are unstable.
For instance, properties in areas with slow property price growth or high crime rates may be considered less desirable and harder to sell in the future.
What Lenders Look for in Property
- Location: Properties in well-established, high-demand areas are more likely to hold their value and may be approved more easily.
- Condition: If the property is in poor condition or requires major repairs, the lender may be hesitant to approve the mortgage.
- Rental potential: If you’re buying an investment property, the rental yield and the property’s potential for growth will be important considerations for the lender.
To avoid complications during the approval process, ensure that the property you’re purchasing is well-maintained and in a desirable location.
Conclusion
Understanding the top 5 factors lenders consider when approving your mortgage is vital for making an informed decision.
By focusing on improving your credit score, increasing your deposit, managing your DTI, and ensuring the property meets the lender’s requirements, you can improve your chances of getting approved for a mortgage.
If you’re unsure about the details, seeking guidance from a financial advisor or mortgage broker can help you navigate the process with confidence. With proper preparation, you’ll be well on your way to homeownership.
Frequently Asked Questions
How can I avoid paying LMI?
To avoid paying Lenders Mortgage Insurance (LMI), aim for a deposit of at least 20% of the property’s value. Alternatively, some lenders may allow you to use a guarantor or apply for government schemes that reduce the deposit requirement.
Does my credit score affect my interest rate?
Yes, your credit score can influence the interest rate you are offered. Borrowers with higher credit scores are typically offered lower interest rates, as they are considered less risky by lenders.
Can I get a mortgage with no deposit?
While it is possible to get a mortgage with no deposit, it is generally difficult. Lenders may offer no-deposit loans in some cases, but these often come with higher interest rates, and you may need a guarantor or special government assistance.