Red Flags To Mortgage Lenders And How To Avoid Them

Getting a mortgage is a stressful process. According to Rocket Mortgage, even the very beginning of the mortgage process, pre-approval, has buyers in a tizzy because they aren't sure if it hurts their credit score (hint: it doesn't in the long term). Add in moving because of a big life event, family emergency, or change in job, and you definitely don't want to look like a walking red flag to your mortgage lender.

If you've spent most of your life renting, transitioning to being a homeowner can be an exciting, but daunting possibility. The modern real estate market moves quickly. Once you find your dream home, you'll want to secure your financing as quickly as you can so you don't miss out. If you want a quick and painless financing process for your home (whether it's your first time buying or fourth), avoiding these key things will make the entire process easier.

Mortgage lenders need to know you are good at handling debt. After all, your mortgage is likely hundreds of thousands of dollars. If you have no credit score, or a poor credit score, it's a big red flag to most lenders. They will be apprehensive about loaning you large amounts because they won't be sure about your ability to pay it back. To avoid this, as soon as you start saving up for a house, start working on your credit, too.

You can get poor credit from having too much debt or missing payments. To raise your score, you need to lower your monthly balances and be sure to always make the minimum payment on time. According to CNBC, sometimes the problem isn't that you have poor credit, though. It's that you have no credit at all. To fix things before applying for a mortgage, there are a few things you can do. The first thing is to ask a family member, partner, or trusted friend if you can become an authorized user on their card. Just be sure that they have a good credit score and manage their debt responsibility. You only need to make a few charges on the card (and pay them off) for it to start working in your favor. From there, you can apply for a card of your own.

Mortgage lenders are okay with lending you money if you already have debt. They just want to make sure that you can pay the debt you currently have, plus the money they are about to give you, all on your current income. This is where your debt-to-income (DTI) ratio comes in. According to the Consumer Financial Protection Bureau, you calculate your DTI by dividing your monthly payments by your gross monthly income (so before taxes, bills, etc). Different lenders have different requirements for DTI, but the general trend is the lower the better – and no higher than 36% (via Better Money Habits).

If you need to lower your DTI to qualify for a better mortgage, there are a few things you can do. The first thing is to bump up your monthly payments, even by small amounts like $50 or $100. Putting more money towards the loan shortens its life, reduces the amount of interest you pay overall, and lowers your DTI. You can also consider delaying larger purchases, like a new car or going on vacation in the months leading up to your mortgage application, or even small pleasures like eating in restaurants, to throw more money at your debt.

As you prepare to apply for your mortgage, pay close attention to the amount you are spending each month. As lenders will look back over your most recent bank statements to determine your loan eligibility, any account overdrafts present are a sign of financial distress and a huge red flag to lenders. Watch your spending in the months leading up to your application. According to Investopedia, an overdraft is where you pull more money from your account than is available. It might happen to most of us around payday. We know our direct deposit is on its way, and we have bills to pay ... so we just hope that our paycheck hits before the other payments go through. And unfortunately, sometimes it doesn't, so an overdraft occurs.

Banks typically charge an overdraft fee, usually around $35, and also charge interest on the loan. This fee and interest can easily cause even more financial distress, especially if you are trying to buy a house. To avoid an overdraft, keep a close eye on all your accounts as you prepare your mortgage application. If you are worried about going over, consider turning off autopay on a few bills so you have complete control over when money leaves your account.

If you are employed by a member of your family, you might have a little bit more explaining to do when you apply for a mortgage. Some mortgage lenders might assume that your employment situation is just short term to qualify for a loan. Something along the lines of, "Oh sure, I'll put down that I pay you this much a year. You are sure to get a great mortgage!" If your employment is legitimate, you will need to have a long-term contract to prove it.

According to Credit.com, your job really matters when applying for a home loan, as your annual income is the best long-term indicator of whether or not you will be able to make your mortgage payments. When you work for your family, you will need to go out of your way to prove it is the real deal. This means that, depending on how things run around the office, your employer will need to make a few changes, too. For example, all documentation must be official – it can't be handwritten (via Home Loan Experts). You will also need a longer paper trail proving your previous year's income, as well as a letter confirming your role.

Lenders will go over your bank statements with an eagle eye. So you should be sure to have documentation for exactly where all the money in your account came from. According to Rocket Mortgage, this process is called Proof of Funds, or POF. Essentially, lenders just want to confirm that the large sum deposited in your account two weeks ago really was a gift from your grandparents and not a loan that you will have to pay back just after you close on your house.

The POF process is a familiar one to banks, so obtaining proof that everything is legit (if, of course, it actually is) isn't that difficult. You just need to obtain a POF letter from your bank. The letter should come on official letterhead and include the following information, at minimum: Your bank's contact information, the official bank statement containing the deposit plus the total number in all your accounts, and the signature of a bank employee – or a notary. This declaration is binding, so if you say the money was a gift, get it notarized and then send the money back to its owner later on, there could be consequences.

This is a pretty big red flag, but due to the nature of moving, it unfortunately happens a lot: don't take out a new loan while you are in the process of securing a mortgage, or you might have to start all over again. We know, moving usually comes with a lot of life changes. You might be moving from the city to the 'burbs and realize that relying on public transportation won't work anymore. So you buy a car ... but you take out a loan to do so. Next thing you know, your lender is on the phone saying your debt-to-income ratio is totally different now and you aren't approved for your mortgage anymore. It can unfortunately happen.

According to The Ascent, another type of loan people apply for when taking out mortgages is a personal loan. In some select circumstances, a personal loan can temporarily improve your credit score and boost your cash reserves, so it works in your favor. However, the key, as always, is to apply for all of these before you begin applying for mortgages, so nothing changes during the process.

A mortgage application is one of the most important documents you will prepare in your life. Take your time to really slow down and be sure that there are not any typos. If something is incorrect, a mortgage lender can't be sure whether you accidentally made a mistake, or are trying to purposefully mislead them, so be extra careful. According to Carrington Mortgage Services, even the smallest of details can have a big impact.

For example, the spelling of your name as Zoe Smith can be reported differently to credit bureaus than Zöe Smith, as can Jonathen vs. Jonathan. Tracking down these mistakes after the fact and correcting them can negatively impact your credit score. Even more so would be a missed decimal point in something like your yearly income or current debt. Reading documents over and over again can make you exhausted, so be sure to take a break before you proofread your application, or have a trusted friend or family member comb through it, too.

When we think about debt, the same kinds of things come to mind for most of us. Things like consumer debt from our credit cards, student loans from our time in college, or a car note for our minivan. But there are other smaller, more sneaky kinds of debt that also need to be declared to our mortgage lenders so they have the full picture of our financial situation.

According to The Consumer Financial Protection Bureau, things like child support payments and alimony are considered when applying for a mortgage. So, if you have to pay them, or even receive them, make sure to include them in your application as they impact the bottom line. In some cases, these amounts can be quite substantial. In order to prove your income or liability, ask your lawyer for a copy of the summary declaring the amounts and for how long they need to be paid (via Free and Clear).

To avoid private mortgage insurance (PMI), you need to put down a deposit of at least 20% of the home's total purchase price. While some loan programs allow for smaller down payments (as low as 3%), this can make the process more difficult. According to HSH, determining the correct amount for a down payment can be a bit of a gamble. "It's important to ask the right questions about how various down payment amounts will affect your mortgage insurance and mortgage payments," says Keith Gumbinger, vice president of HSH.com. "You need to figure out if it's worth begging your parents for a certain amount of cash."

If you choose to participate in a program like the Federal Housing Administration (FHA) loan, your main goal should be boosting your credit, not your cash reserve because if you want to claim that low 3% deposit, your credit needs to be phenomenal. If you go the more traditional route of 20%, your goal should be pretty good credit, but it doesn't have to be as high since you are putting down more cash upfront.

Lenders like consistency when looking at your income. They want to make sure you are going to be able to pay them the total amount of money that you owe them each month. If your income goes up and down from year to year, or even month to month, be sure to have documentation as to why. According to The Mortgage Reports, a situation where this might come up is if you run your own business, or are a 1099 contractor, instead of a W-2 employee. Typically, mortgage lenders will want to see at least two years of steady work before approving you for a mortgage. To them, this is a long enough time to prove that you will be able to pay them back.

In addition to this, most mortgage lenders like to look through your past work and clients to ensure that the work that you do will be consistent and ongoing. The loan officer will perform a thorough audit of your business finances to make sure that everything will continue as you have said. This can be nerve-wracking if you are in a business impacted by outside factors, like a tourism business during the COVID-19 pandemic.

If you often bet on the races, make trips to Las Vegas, or enjoy any other sort of gambling, mortgage lenders might raise an eyebrow at your application. Depending on how much you gamble, they might worry that their monthly payments could be lost. According to Mortgage Loan, your discretionary spending isn't an issue for most mortgage lenders. Spending money betting on your favorite sport every once in a while is no different than going on vacation and splashing out on a big dinner. However, the problem arises when you attempt to use your winnings to pay for your house.

Professional gamblers typically cannot qualify for a home loan on their own. This is because banks see their income as too risky. In the rare case that they do find a lender, the interest rate on their loan is typically higher than most, as the bank charges more to attempt to protect their asset. Just to be on the safe side, if you enjoy betting, it's best to stop playing for at least three months before your mortgage application. If you want to play it safe, try to keep credits off your statement for at least six months. This will make you seem like a lower risk.

Life events like getting married, getting divorced, having a baby, etc. impact our finances. Lenders might be wary of people applying for a loan during these times, although they usually coincide with wanting to buy a house. According to Mortgage Loan, if you find yourself going through a big life change, be ready to provide extra documentation on how your finances will continue to cover all payments due.

"We look at each customer based on factual data and credit score," Ray Rodriguez, a bank regional sales manager told the website. "Whether they are married, not married, in a domestic partnership, engaged or single, that plays no role. We just want to make sure they can make their payments." The key here is that the factual data changes depending on your personal situation. When you get married, your spouse's credit history begins to impact yours. When you get divorced, your alimony payments drive up your DTI. However, if you suspect discrimination when applying for a mortgage, don't hesitate to report it (via the Federal Trade Commission).

When determining the size of your mortgage, lenders look at your bank account for the past three to six months. They want to see a trend of your money growing in the lead-up to them lending your hundred of thousands of dollars...not shrinking. According to Ramsey Solutions, most people just save up for the cost of their home's down payment but forget about all the other expenses involved in buying a house. Unfortunately, these people are in for an unpleasant surprise when the bill comes, or the mortgage company approves them for a smaller mortgage than expected.

These other financial responsibilities are closing costs (usually about 5% of the home's total price) and moving fees. You also can't forget furnishing your new home, possible higher property taxes, and repairs and maintenance. To avoid being a red flag to your mortgage lender, look over your financial history from their perspective. Does it seem like it's growing?