Understanding the Criteria of a Lender’s Decision to Fund a Loan
Ultimately, you will find that lending decisions are based on three points. Sometimes these three items are referred to as "the lending triangle" or "the three legs of the lending stool", but the concept is the same no matter the nickname given.
To understand these three ingredients is to understand how lender’s view your profile and determine the risk grade a borrower will receive.
Credit (Fico score) - sounds simple but a lot of factors go into this item. Your credit scores are the predominant evaluation in this side of the triangle. But, it doesn’t end there. Have you had a mortgage before? Did you pay in a timely fashion? Do you have established trade lines (credit cards, vehicle loans, etc), and how is your pay history with them?
Collateral (LTV = loan to value) - the main idea of this item is the amount you will be borrowing versus the appraised value of the home. The higher you borrow in relation to the value, the greater the risk the lender has of default in most cases. The more you have vested in the home, the less the risk you will walk away in rough times.
Abilty to repay (DTI = debt to income) - the lender wants to know, what you will be earning versus what you will be paying when the loan funds. The idea here, is that the higher the percentage of your income it takes to pay your mortgage, and related items (i.e. homeowner’s insurance, Property taxes, etc) and all other bills combined the greater the risk to you and the lender.
Fortunately, there are "compensating factors" that help out. Such as "reserves"like a 401k, which show the lender an ability to repay (and save!). The best tactic is to build up the stronger "legs of the lending stool" to help make up for a weak leg.
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