Most people know about the many benefits and rewards of becoming a homeowner. What most don’t know is what it takes to qualify to buy a house.
Now more than ever, there is a lot of confusion about getting qualified for a mortgage – and a lot of misinformation as well. It’s common to hear people say, “I heard banks aren’t lending money right now,” or, “I heard you need to have 20 percent down to get a mortgage these days.”
As a mortgage banker, I hear these things a lot. So today, I’m dispelling the myths and offering the basic information you need to know about qualifying for a mortgage. This information is important whether you are a first-time home buyer or current homeowner who hasn’t gotten a home loan in several years.
While mortgage underwriters look at a lot of different information to determine whether you’ll qualify for a mortgage, ultimately, it comes down to four things: credit, equity, income and assets.
Your credit is one of the most important things that will be considered when determining if you qualify for a home loan. It’s also one of the things that most people don’t know a lot about. Your credit history is how a lender will judge the likelihood that you’ll pay them back the money they lend you. To do this, a lender will look at the length of your credit history, how reliably you’ve paid on your loan accounts and if you’re maxed out on credit cards or loans. These are also the factors that determine your credit rating or credit score. Your credit score will be used to qualify you for a mortgage and will often determine the interest rate you will be offered.
Credit scores used for a mortgage range between 350 (low) and 850 (high). A healthy credit score is generally considered to be above 740 and a poor credit score is anything below 600. The higher your credit score, the better the interest rate you’ll likely be offered. For most lenders, the minimum score to qualify for a home loan is 620.
In addition to your credit score, lenders will look at items on your credit report. They’ll want to see that you’ve had accounts open for at least a year and that you don’t have any large outstanding collections or judgments against you. If you have collections or judgments on your credit report, you will usually have to take care of those first before you can get financing (the one exception to this is usually medical bills). The other thing that won’t show up on your credit report, but is verified, is your rental history. Lenders want to see if you’ve had any late rent or mortgage payments in the past 12 months. Any more than one late payment and you’ll have a tough time getting approved.
Equity / Down Payment
Buying a Home
The minimum required down payment when buying a primary home is typically 3.5 percent of the sales price, which will allow you to get an FHA loan - a great option for first-time home buyers or anyone who can’t come up with a huge down payment. FHA loans also don’t penalize you with a higher interest rate if you have less-than-perfect credit. Another option is a conventional mortgage. Conventional loans typically require 5 percent to 10 percent down depending on the lender.
When buying a home, keep in mind that you will not only need to have funds for the down payment, but you will also need additional cash for various settlement fees. These can range quite a bit depending on the type of the loan and the area where you are buying; talk to a trusted lender to learn more. The good news is that home loan programs allow you get a credit from the home seller to help pay for these settlement fees, as well as additional costs, like your first year’s taxes and insurance.
The biggest obstacle for many homeowners right now is the equity – or lack thereof – in their homes. The housing market has taken a historic plunge and many people find themselves with much less equity in their homes than they did a few years ago. Many people also find themselves “underwater” in their homes, actually owing more on the mortgage than what the house is worth. Generally, you can only finance up to 95 percent to 98 percent of the appraised value of your home. If an appraisal on your home comes in low, you may be required to come up with additional funds to close on your loan, or not get a loan at all. If the appraisal comes in so low that you’re underwater, you still have a few options. For specifics, talk to your mortgage lender.
Income vs. Debts
Another factor looked at by lenders is your debt-to-income ratio (DTI). This is simply your fixed expenses with the new mortgage compared to your gross monthly income (income before taxes are taken out). Lenders typically want to see someone spending less than 50 percent of their gross monthly income on these fixed expenses, which include your mortgage payment, property taxes, association dues, home owners insurance, car loans, student loans, credit cards and any other fixed payments that would show up on your credit report. Variable expenses like utilities, phone and cable are not included in your DTI.
Lenders also want to see a good employment history and will verify your past two years of work. It’s much more difficult to qualify for a mortgage if you don’t work a typical “nine to five” job, are part-time or self-employed. For these scenarios, you will need to have been at your job for the past two years and your income will usually be averaged. If you are self-employed, expect to fork over your tax returns, as “stated income loans” are a thing of the past. If you have a lot of different tax write-offs to minimize what you pay Uncle Sam, you may not be able to prove enough income to qualify.
Lenders also verify that the funds you will use for your down payment are in a liquid account, like a checking account or savings account. If you like to keep your cash in a pile under your mattress, you may have trouble getting approved for a loan and will need to deposit that cash into a bank account. Lenders need to see where all the funds being used in the transaction are coming from and there is no way to document loose cash.
Sometimes, in addition to the funds you will use for the down payment, there is an additional requirement that you have cash reserves. This varies from lender to lender, and will depend on the type of financing you are trying to get. Reserve requirements are more common if you’re buying an investment property or second home, rather than a primary residence. In most scenarios, the requirement will be two to six months worth of mortgage payments in liquid reserves.
In sum, there are many different factors that go into qualifying for a home loan today. Hopefully, this breakdown will help you figure out where you stand and whether now is a good time to apply for a new home loan. When it comes to obtaining any home financing, make sure you talk to a good mortgage lender who will walk you through all of the specifics.
Eric Ehrhardt is a home loan expert with Quicken Loans, America’s #1 Online Mortgage Lender. He has more than 6 years experience in the mortgage industry and prides himself on educating his clients on which loan options make the most sense for their situations.
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