Buying a home requires financing in most cases. Homebuyers usually don’t have the cash to buy a home outright, so they need a mortgage. That’s not such a bad thing; in the U.S. especially, buyers can take advantage of amazing long-term financing terms. Getting approved for a mortgage often seems overwhelming, but when you know what to expect, it’s not as bad as it seems! This article will explain qualifying for a mortgage so you can be a prepared buyer.
Qualifying Factors for a Mortgage
Lenders look at many factors including your credit score, income, debt-to-income ratio, down payment, and the home itself. Check out the qualifications you need to secure mortgage financing.
Your credit score is the first impression lenders have of your financial worthiness.
It’s important that you make it as good as possible! Not only will it help you in qualifying for a mortgage, it directly influences the interest rate you’ll have to pay.
Ideally, a credit score of 680 gets your foot in the door with the best loan programs. That doesn’t mean you can’t get qualified without this score, as government-backed programs, such as the FHA loan have credit score requirements as low as 580.
Generally speaking, a credit score over 720 should get you the best rates on most mortgage loans.
The higher your credit score, though, the better the loan program you can secure, along with a lower interest rate.
Lenders charge higher rates and closing costs for borrowers with lower credit scores.
Ways to Boost your Credit Score
If you’re thinking your credit score isn’t as high as it should be, use these simple tips to increase your score before getting approved for a mortgage:
- Get your payments current. Late payments hurt your credit score the most since your payment history makes up 35% of your credit score. Bring all payments current and keep paying your bills on time to increase your score.
- Lower your credit utilization. The amount of credit you have outstanding compared to your credit line makes up 30% of your credit score. Ideally, you shouldn’t have more than 30% of your credit line outstanding at once. For example, a $1,000 credit line shouldn’t have more than a $300 balance.
- Keep your accounts open. Your length of credit history is important. It gives lenders a chance to see your patterns. Even if you pay a credit card off and don’t use it, keep it open to boost your credit score.
- Carry a decent mix of credit. Don’t carry all revolving credit or all installment debt – have a decent mix to give your credit score the boost it needs.
Proving your Income
Lenders need proof of the income you say you make. They’ll ask for:
- Paystubs covering the last 30 days (4 paystubs if paid weekly, 2 if paid bi-weekly)
- W-2s for 2 years if you work for an employer and don’t earn 100% commission
- 1099s for the last 2 years if you are a contractor or sole proprietor
- Tax returns for the last 2 years if you’re self-employed, a contractor, or a business owner (partnership or corporation)
- Other documents as they need them
Lenders look at how much debt you have compared to your gross monthly income (income before taxes).
The ideal debt-to-income ratio (DTI) for most loan programs is less than a 45% total DTI.
This means your total debts are less than 45% of your income. Your total debts include your credit cards, car loans, student loans, and other installment loans, plus the new housing payment.
If it exceeds 45%, you won’t be approved in many cases, or loan terms will be much worse.
If you are a house-hacker, keep in mind that the income you bring in from your rented units counts as income. Lenders use the projected income based on the area’s average rent to qualify you for the loan.
Saving Your Down Payment
Your down payment is a crucial piece of the puzzle when getting approved for a mortgage.
While there are programs that require no down payment, most borrowers need at least 3.5% down for FHA financing or 5% down for conventional financing (3% for first-time homebuyers).
It’s important to save early for your down payment. You may need thousands of dollars to put down on the home.
Even if you live paycheck-to-paycheck, saving for a down payment is as simple as:
- Cutting the cord on cable
- Easing up on eating out or entertainment
- Shopping sales and using coupons
- Getting cheaper insurance
- Shopping for cheaper cell phone rates
- Working a side hustle for extra income
All savings can go to this goal. It will likely take a significant amount of time, but it doesn’t have to be complicated.
Any money you save can go a long way towards building your down payment.
Get a Mortgage Pre-Approval
Once you’ve prepared your finances as best you can, it’s time to get pre-approved.
Talk with a few lenders to get an idea of where you stand. Each lender has different loan programs and/or requirements, so shopping around is crucial.
Once you choose a lender, get a mortgage pre-approval letter.
This letter will get your foot in the door with sellers and real estate agents. They want to know that you have the necessary financing to buy the home and aren’t wasting anyone’s time.
Many sellers won’t accept a bid on the home unless you have official proof that a lender will finance you.
The Deal with Appraisals
After you ensure that you’re qualified for a home loan, it’s time to worry about the appraisal.
The property must be worth at least as much as you agreed to pay. If not, you may have to pay the difference between the appraised value and the purchase price as lenders will base your loan amount on the appraised value.
The appraisal plays a large role in your approval, especially if you’re looking for a non-owner occupied mortgage.
Lenders put more emphasis on the property itself than your qualifying factors.
They need reassurance that the home is worth more than enough that if they have to foreclose on the property that they won’t suffer a huge loss.
But, so long as it appraises, you’ll be just about set for closing on the property!
Conclusion – Qualifying for a Mortgage
Start preparing yourself for mortgage approval ahead of time.
Check your credit and see what you may need to improve.
If your credit needs a boost, take the steps to fix it now.
Also look at your income. Would it be easy to a lender to understand?
Do you have consistent and reliable income?
If not, take the steps to make your income looks as presentable and stable as possible.
In the end, lenders look at the big picture. If you don’t have perfect credit, but you have a large down payment and the home appraises for the right value, you may still be a good candidate.
This isn’t a one-size-fits-all solution. Qualifying for a mortgage is part art and part science. Work with a few lenders to see where you can get the best deal and get your mortgage pre-approval before you start.
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