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Sep 2017

Top Reasons a Mortgage Differs from Other Loans

Taking out a loan is a big deal, whether it’s for a home, a vehicle, or for higher education. But not all loan types are created equal – and mortgages are among those with the most stringent requirements. For many, buying a car is the first foray into taking out a loan, so the complexity of the mortgage application process may be a bit surprising for first-time homebuyers.

Understanding the differences

Perhaps you’re considering buying a home, but wondering how different types of loans stack up so you’ll know what to expect with applying for a mortgage. Below, we’ll go into detail about several different loans and why qualifying for a mortgage has greater requirements.

Buying a vehicle

A vehicle purchase may seem like a fairly large amount of money – and it is – but in comparison to a mortgage, it’s actually quite small. However, that doesn’t mean that just anyone will be approved for an auto loan. Here’s how buying a car stacks up against obtaining a mortgage:

  • Credit Reports and History – As with any type of lending, your credit report will be carefully studied to determine if you qualify. In the case of a car loan, lenders may only review one of the three big credit reports (Experian, Equifax and TransUnion) – whereas, mortgage lenders tend to look at all three with a fine-tooth comb. Credit dings make it extremely difficult to qualify for a mortgage, but don’t necessarily affect your chances of obtaining a car loan.

  • Risk Tolerance – A lender is always taking on some form of risk when providing a loan to a borrower, but the amount they’re willing to take varies widely between an auto and home loan. The car industry tends to be less risk-averse because the end goal is to sell the most cars – but they still protect themselves by requiring less credit-worthy individuals to pay a higher interest rate.

  • Timeline – If you’ve ever purchased a vehicle, you probably know that the timeline from test drive to signing the title is a pretty quick process (if you count sitting in a dealership for several hours ‘quick’). On the other hand, a mortgage loan can take a month or more while it goes through the full approval process. And let’s not forget the repayment timeline – a typical auto loan is for a 3-, 5- or 7-year period, while a fixed-rate mortgage is usually repaid over 15 or 30 years.

Applying for student loans

Attending college is expensive, so there’s no surprise that nowadays, it’s extremely common for college students to have debt in the form of student loans. But, while it may not be an ideal situation, borrowing money now to receive an education may pay off down the road. Here’s how student loans differ from mortgage loans:

  • Credit Report and History – If you’re applying for a federal student loan, a credit check is not required (in most cases). You must meet certain qualifications, but otherwise, your credit history (or lack thereof, as most students have no credit history) is not as prominent of qualifying criteria. This is vastly different from the mortgage process, where your credit reports and history play a significant role.

  • Interest – An unfortunate aspect of student loans is the interest rate variability. The federal loan rates are set annually by the 10-year Treasury note and are often higher than the interest rates of 30-year mortgages. When it comes to obtaining a mortgage loan, your interest rate will depend on the type of mortgage you choose. Choosing a fixed-rate option means your interest rate will not change during the life of the loan.

  • Payments – There are many options for repaying student loans, including income-based plans. While these plans offer you a smaller monthly payment amount, if you aren’t paying enough to keep up with the growing interest, that unpaid interest will be added to the principal owed. This means your loan can grow larger over time. Fixed-rate mortgages differ in this respect, as interest is factored into the overall repayment amount and divided up evenly over the life of the loan.

The mortgage application process

As you saw from the comparisons above, obtaining a mortgage tends to be a much stricter process than applying for other types of loans – a process that has only become more tedious since the housing crisis in 2007-2008.

  • Credit Report and History – Having good credit is key to obtaining a mortgage. And the better your credit score, the better your interest rate and loan terms will be. You’ll also need to show proof of two years of consistent income, which means business owners, freelancers and those just starting their careers may find it challenging to gain approval.

  • Debt-to-Income Ratio – As part of the mortgage approval process, your lender will calculate your monthly debts and monthly income sources to determine your percentage of debt. This ratio gives lenders an idea of your financial strength and protects you from spending more than you can afford. In most cases, your debt-to-income ratio should be 43% or less in order to be approved for a mortgage loan.

  • Assets – A lender will want to see your assets (specifically those of the liquid variety), because this will help paint a picture of how you’ll afford a down payment and your monthly mortgage payments. Also, certain types of loans require you to have reserves built up for a specified number of months in order to qualify for a mortgage.

These detailed lending requirements are in place to protect you as a homebuyer, but also to protect your lender. Carefully vetting mortgage applicants helps lenders ensure they’re able to underwrite and sell your loan, which they almost always do to free up their credit lines to lend money to other borrowers. When you’re ready to take the next step toward homeownership, contact a mortgage banker.