If you are approaching homeownership, you will likely have to consider the subject of a mortgage. With this, it’s important to understand how best to navigate them.
How do banks calculate how much you can borrow? How can you borrow more if you don’t qualify for the amount you need?
We’ve put together this guide to answer these questions and more. Read on to learn about mortgages, how much you can borrow, and what factors will come into play.
How Do Banks Determine How Much a Person Can Borrow?
Loan amounts are often dependent on whether the lender views you as high or low risk. If you are viewed as high-risk—often characterized by erratic spending, low credit scores, and standing debt—you will be offered a lower amount on average. If you are viewed as low risk, there’s a chance you may be offered even far more than you need. This is because:
- Banks want to lend large sums when they’re confident they’ll get the money back (with interest). The more they lend, the more interest they get back.
- If banks determine a borrower is high-risk, they offer lower amounts with higher interest rates. The high interest is to mitigate the risk of the borrower defaulting later on.
When calculating how much money it can loan to you, a bank will consider many factors. Three of the most important are as follows:
Debt-to-Income Ratio (DTI)
Your debt-to-income ratio is the percentage of your monthly income that goes toward your debts. It is used by lenders to determine a borrower’s level of risk, and ultimately the amount that can be lent.
You can roughly calculate your DTI by dividing your regular monthly debt payments by your monthly income. These debt payments include your future mortgage repayments. Say your debt repayments were $1,000, and your monthly income was $2,500: your DTI ratio would be 40%.
Most lenders cap the DTI ratio at 43%. With the above example, your DTI still falls below the cap, but may categorize you as high-risk.
Your DTI ratio isn’t the only thing you should think about. Realize that the bank will also take into account your credit score.
A good credit score indicates to the lender that you are a reliable borrower. They can loan you money knowing that you won’t leave them out of pocket or make late repayments.
Ability to Make a Large Down Payment
A large down payment can help you secure better terms, with most lenders considering 10-20% to be a strong offering.
If you can confidently put up more, even better! You’ll keep the bank happy by giving them more money while decreasing the amount you have to pay back in installments.
How Much Can I Borrow for a Mortgage?
Some lenders will let you borrow as much as 30-40% of your gross income. But, just because the cap is this high doesn’t mean you should max out.
It’s important to only borrow what you can afford. As a general rule of thumb, it may be wise to borrow no more than 28% of your gross income.
What to Do If a Bank Won’t Loan You Enough to Buy a Property
There are 3 main options when a bank won’t loan you enough to buy a property:
- Try another lender. Not all lenders cap DTI ratios at the same limit, as each has its own calculations.
- Consider buying a less expensive property. Given how hard it is to find a property you want to live in, this isn’t an easy option. However, if you can’t find a way to access the money you need for your first-choice property, this may be the only option.
- Try to improve your position and get better lending terms (see below).
How to Increase the Amount a Bank Will Loan You
If a bank refuses to lend the amount you need, you have a few options available to try and increase your loan amount:
- Improve your DTI ratio. Easier said than done — if increasing your income was as easy as saying it, we’d all be millionaires. However, if you can reduce your monthly debt, this is a good start.
- Save for a larger deposit. This is often an achievable goal and a great way of securing a larger loan from the bank.
- Build a better credit score. If you can improve your credit score, the bank will consider you a lower risk for lending large amounts.
How to Prepare to Apply for a Mortgage
Here are a few tips for putting yourself in a good position before you apply for a mortgage.
- Research lenders. Applying for a mortgage is arduous, even if it works out the first time around. Find a lender whose terms seem like the best fit for your situation.
- Get your paperwork in order. Everything from identity documents, to bank statements, to proof of deposit. Even if it’s not an ‘official’ part of how banks determine how much they want to lend, there is a human element to lending. For companies like banks, this is the ‘notes’ section of a client file, and you don’t want yours to show that you’re unreliable with paperwork.
- Dress your accounts smartly. We all know about putting on our best clothes before going to the bank — making a good impression is essential. Treat your finances the same way. You’ll have to provide documents such as bank statements, which you won’t want to look too erratic. Try to ensure that you’ve had consistent, strong bank activity for at least 6 months before applying.
Conclusion: How Much Can I Borrow for a Mortgage?
While borrowing for a mortgage may seem daunting, hopefully this guide will make it easier to understand at face value. Being familiar with the process means you can improve your chances of securing the mortgage you need.
For additional help and access to all the expertise you may need to make the right mortgage decisions, contact our team at Associates Home Loan today.