What Do Banks Look at When Buying a House?

When applying for a home loan, banks evaluate your eligibility and the property’s suitability. They assess financial factors to determine lending risk and ensure the loan is secured by collateral.

Your Financial Health and Capacity

Banks examine a borrower’s financial standing and ability to manage mortgage payments, reviewing income stability, employment history, creditworthiness, existing debts, and available assets.

Lenders prefer a consistent income stream and stable employment history, often requiring two years of continuous employment. Job changes are acceptable, especially within the same industry or with increased pay, if income is sustainable. Banks consider various income sources (salaries, hourly wages, bonuses, commissions, self-employment income), though self-employment may require more documentation.

Banks heavily weigh credit score and history. A FICO score (300-850) indicates a borrower’s likelihood of repaying debt. A “good” FICO score (670-739) can improve approval chances and lead to better interest rates. Lenders analyze payment history, credit types, history length, and amounts owed to gauge credit behavior.

Banks use the Debt-to-Income (DTI) ratio, comparing a borrower’s total monthly debt payments to their gross monthly income. Most lenders prefer a DTI ratio of 36% or below, though some approve higher ratios with compensating factors. This ratio helps banks assess a borrower’s capacity for housing expenses alongside existing financial obligations.

Banks also scrutinize assets and savings, including funds for a down payment, closing costs, and post-closing reserves. Liquid assets like checking, savings, and investment accounts demonstrate financial stability and the ability to cover unexpected costs or reduced income. A larger down payment can reduce the loan amount, lowering the bank’s risk.

The Property’s Value and Condition

Banks assess the property to ensure it provides adequate security for the loan. This evaluation involves an appraisal and a title examination, protecting the bank’s investment by confirming the property’s market value and legal standing.

A home appraisal is a professional assessment of the property’s market value, conducted by a licensed appraiser. The appraiser evaluates the property’s characteristics, including size, condition, and location, comparing it to recent sales of similar homes. This ensures the property’s value supports the loan amount, mitigating bank risk. If the appraised value is lower than the agreed-upon sale price, it can impact the loan amount the bank is willing to provide.

A title search confirms legal ownership and identifies any claims or encumbrances on the property. It reviews public records for liens, unpaid taxes, judgments, or ownership disputes that could jeopardize the bank’s interest. A clear title ensures the bank can establish a first lien position. Title insurance is required to protect both the buyer and the lender against unforeseen title defects.

While property inspections are for the buyer’s benefit, significant issues in an inspection report can affect the bank. If an inspection uncovers major structural problems or defects that could impact the property’s value or future marketability, the bank might require repairs before finalizing loan approval to protect its collateral.

Required Documentation for Loan Application

Banks require documents from applicants to verify financial and property information. Gathering these documents in advance can streamline the application process.

For income verification, applicants provide pay stubs, W-2 forms for the past two years, and personal tax returns for the last two years. Self-employed individuals or those with significant commission/rental income may need to submit 1099 forms, profit/loss statements, or business tax returns. These documents help the bank confirm income consistency and reliability.

Asset verification involves submitting bank statements for checking and savings accounts, usually for the most recent two to three months. Statements for investment accounts, such as retirement accounts, stocks, and bonds, are also required. If a portion of the down payment is a gift, a gift letter from the donor and documentation of funds may be necessary.

To verify credit and debt, lenders pull a credit report. Applicants may need to provide statements for existing debts (credit cards, auto loans, student loans) to confirm balances and monthly payments. Identification is a standard requirement, such as a government-issued photo ID (driver’s license or passport) and proof of Social Security number.

Property-related documents are essential. These include the executed purchase agreement, recent property tax statements, and homeowners’ insurance declarations. These documents confirm the details of the transaction and ensure the property is adequately insured from the outset.

The Mortgage Application and Underwriting Process

After gathering all necessary information and documentation, the mortgage application proceeds through several stages: formal submission, detailed review, and final approval.

The process begins with pre-approval, where a bank provides an estimate of the maximum loan amount based on a preliminary review of an applicant’s finances. This involves submitting initial financial documents and allowing a credit check, resulting in a conditional commitment. A pre-approval offers a strong indication of borrowing capacity and is often required by sellers in competitive housing markets.

Following pre-approval, the formal application is submitted with all required documentation. This initiates a thorough review by the bank’s underwriting department. Underwriting is a detailed assessment where the bank scrutinizes financial information, credit history, and property details to evaluate risk. Underwriters verify income, employment, assets, and debts, ensuring everything aligns with lending criteria and regulatory requirements. They may request additional information or clarification during this phase.

Once the underwriter completes their review and all conditions are met, the loan receives final approval. This leads to closing, where all legal documents are signed and funds are disbursed. At closing, the borrower signs the mortgage note (agreeing to repay the loan) and the deed of trust or mortgage document, which secures the loan with the property. The borrower pays closing costs, which include various fees related to the loan, appraisal, title, and other services.