Qualifying For A Mortgage: What To Know
Browsing homes online can be enticing, but homeownership typically involves bringing a lender into the home buying process. Most buyers need a mortgage lender to finance the home of their dreams. As exciting as the home buying journey can be, it’s vital to understand how to qualify for a mortgage. With the backing of a lender, you can confidently walk into negotiations with a seller and follow through on the home purchase.
Qualifying for a mortgage means presenting your financial circumstances to a lender to examine and determine if you can handle the financial commitment. Your credit, monthly income and debt obligations can make the difference between obtaining financing or receiving a denial. Here’s how to give yourself the best possible chance to qualify and the mortgage products available to borrowers.
What Does It Mean To Qualify For A Mortgage?
Qualifying for a mortgage means demonstrating to your lender your ability to uphold the financial responsibilities of a home loan. By reviewing your income, debt, credit score and assets, your lender determines if you’re able and willing to pay back your mortgage. In addition, the bank evaluates your desired home with an appraisal to ensure the home is worth the loan amount.
Mortgage qualification is critical to the home buying process because you can’t get a mortgage without qualifying with a lender. Since most home purchases require lender financing, qualifying for a mortgage is an essential step in the journey.
How Do You Qualify For A Mortgage?
If you want to buy a home, one of the first steps is choosing a lender and getting mortgage preapproval. Applying involves submitting your financial information to verify things like income, assets and employment. The lender will also pull your credit report to see if your credit score is at or above the minimum requirement (usually 620 for a conventional mortgage) and if you’ve handled debts reliably in the past.
With your financial information in hand, the lender determines your estimated loan amount and interest rate. If you pass the preapproval standards, you'll receive a letter from the bank telling you how much they'll lend you for a home purchase.
After preapproval, you can search for a home knowing you have financial backing. When you find the home you want, you'll get an appraisal. This step shows the bank the home is worth the amount they're lending you. This step is crucial since lenders won't provide a mortgage worth more than the home.
For example, say you find a home that appraises for $275,000. However, the seller won't come down from a price of $290,000. Your bank will lend you up to $275,000 to finance the home, regardless of the seller's preferences. As a result, you'll need to either negotiate a lower price with the seller or come up with $15,000 on your own.
In other words, the appraisal phase cements the mortgage amount for which you qualify. This number doesn’t necessarily represent the highest amount your lender would provide you, but the appraisal for a specific home creates a ceiling for your lender. If you’re not satisfied with the appraisal versus the asking price (as in the example above), you can search for another home that fits the range of your preapproval.
Mortgage Qualification Requirements
Passing mortgage qualification requirements is vital to purchasing a home. Remember, different types of home loans and different lenders can have varying requirements, such as credit score and income thresholds.
Borrowers who can demonstrate reliable income are more likely to receive mortgage qualification. Without pay stubs, invoices, or other proof of income, your lender can’t confirm your ability to repay the mortgage. The following types of income will help you qualify:
- Job income
- Overtime income
- Investment income
- Social Security income
- Military benefits
- Income from a second job or side business
- Alimony and child support
Remember, lenders want to see an income stable enough to handle a mortgage. Irregular deposits of varying amounts may not be sufficient to qualify for a mortgage. In addition, income that will end soon, such as payments from an investment account with a few thousand dollars left in it, won’t count as qualifying income.
Assets help assure your lender that an emergency or change in circumstances won't stop you from paying your mortgage. For example, a healthy savings account means losing your job won't prevent you from affording your house payment.
The following assets may be used to help qualify:
- Cash in your bank accounts, including checking and savings
- Individual retirement accounts (IRAs), 401(k)s and other retirement accounts
- Stocks, bonds and mutual funds
- Investment portfolios
- Property, including real estate, vehicles, jewelry and other valuables
Your lender will ask to see relevant documentation demonstrating your assets’ worth. So, you’ll submit account statements from your bank or financial institution showing the cushion your assets provide.
Your debt-to-income (DTI) ratio reflects how much debt subtracts from your monthly income. This figure tells mortgage lenders if you can take on another debt payment. If your monthly debts eat too much of your income, you won't be able to afford a mortgage payment.
You can calculate your DTI by dividing your total monthly debt by your monthly income. Regular expenses such as rent, credit cards, and loans count. Utilities and insurance premiums usually don't.
For example, say you have $4,000 of monthly income. You have an auto loan that costs $200 per month, student loans with a $175 monthly payment, and you pay $1,400 in rent. So, your debt is $1,775 in total. Therefore, your DTI is 1,775/4,000 = 44.4%.
Lenders typically like to see a DTI of less than 50%. Therefore, your DTI would help you qualify for a mortgage in the above example.
Your credit score indicates your reliability as a borrower. You earn an excellent credit score by paying bills on time, keeping debt to a minimum, and successfully handling different types of debt. On the other hand, a low credit score may indicate that you miss payments, have high debt or don’t have much experience handling different types of credit.
Maintaining a high credit score helps you qualify for a loan. Specifically, 620 is the minimum FICO® score requirement for a conventional mortgage. FHA loans and VA loans have less stringent standards, allowing borrowers with scores of 580 or lower to qualify. If you’re a credit-challenged borrower, a down payment of 10% or more of the home value can help you bypass the credit requirements to secure a mortgage.
In addition, a high credit score may help you qualify for a variety of loans and more favorable interest rates. As a result, your credit can reduce your mortgage payment by decreasing the interest you pay on the principal. Even a fraction of a percentage point can equal hundreds or thousands in annual or total costs.
Can I Qualify for A Mortgage?
Whether or not a borrower can qualify for a mortgage depends on how their circumstances fulfill a lender’s requirements. Communicating with lenders about their standards can help you organize your finances and make strides toward qualifying. Specific actions, such as increasing your income, paying off debt and strengthening your credit score can help you qualify.
Tips On Qualifying For A Mortgage
Qualifying for a mortgage means showing you have the capability to uphold the financial responsibilities of a mortgage. The options below can give you an edge when applying with a lender.
Make A Sizable Down Payment
A down payment is often a requirement for buying a home. Typical down payments range from 3% to 6% of the purchase price of a home. For example, a $300,000 purchase with a 5% down payment would mean paying $15,000 at closing.
However, a down payment of 10% or more can help you qualify for a mortgage because it helps the bank take less risk. Using the above example, a 10% down payment would be $30,000, meaning you’ll have 10% equity right off the bat. Doing so leaves you with $270,000 left to borrow. If you’re able to put down 20%, you’ll be able to avoid paying mortgage insurance.
This technique can be beneficial if you have a low credit score since lenders may allow lower scores from borrowers who can make a hefty down payment.
Lower Your DTI Ratio
If your DTI is too high for lenders to approve you for a loan, you can lower it through the following methods:
- Pay off your debt. Credit cards, personal loans and other debts hinder your monthly financial capacity and can weaken your credit. Eliminating outstanding debts will lower your DTI and allow you to use more of your income.
- Increase your income. Whether you ask for a raise, get a second job or change careers, more monthly income means a lower DTI.
- Don’t acquire new debts. Keeping your financial situation stable is key when you’re trying to qualify for a mortgage. Another debt will further unbalance your DTI, sabotaging your efforts.
Improve Your Credit Score
Unfortunately, a low credit score can offset a robust income. Therefore, it’s beneficial to take several months to increase your credit score before trying to qualify for a loan. The following steps can help boost your score:
- Make on-time debt payments for at least the minimum amount due.
- Pay down debts to make bring down your utilization rate, which you want below 30%.
- Wait it out. Part of your credit score is history. The longer you have your credit card or loan, the higher your score can grow.
- Use a tool to boost your score. If you don’t have a mix of credit, score boosting tools from reliable companies will factor monthly bills like phone, cable and utilities into your score.
Remember, it can take time to improve your credit score sufficiently to qualify for a mortgage. However, the effort is worth it: Not only does it allow you to access mortgage products, but a good credit score also provides you more loan options and helps you receive better loan terms.
Find The Best Mortgage Loan For Your Situation
The home buying process can be exhilarating, and jumping on the first mortgage offer you receive is tempting. However, exploring your loan options will help you find the best one for your situation. While conventional loans are popular, government-backed loans can provide additional benefits for borrowers. Plus, shopping around can mean finding a mortgage with a better interest rate, lower monthly payment and fewer closing costs.
A conventional loan is a mortgage without the federal government’s financial backing and are some of the most popular loans. They require a minimum credit score of 620 and a minimum down payment of 3%. In addition, nonconforming conventional loans can help buyers afford expensive homes.
The Federal Housing Administration (FHA) funds FHA loans for buyers with income and credit scores that don’t meet the minimum requirements for conventional loans. The government backs these loans and, as a result, FHA loans are ideal for borrowers who are first-time home buyers or have lower credit scores. However, borrowers must pay mortgage insurance premiums (MIP) regardless of their down payment amount, increasing their monthly payments.
Active military members, veterans and eligible spouses can access VA loans, which provide excellent terms for borrowers. For example, a home buyer using a VA loan has no mandatory down payment requirement. In addition, credit requirements can be more flexible, interest rates can be lower and the VA may provide financial aid for borrowers who default on their mortgages.
USDA loans come from the U.S. Department of Agriculture (USDA) and are for borrowers in designated rural locations. Eligibility depends on where you’re buying a home, so urban areas won’t qualify for this loan type. Likewise, USDA loans are specifically for households making less than 115% of the median household income in the area. In addition, borrowers don’t have to make any sort of down payment to qualify. You can also roll closing costs into your loan. Therefore, if you struggle with income or credit and live in an eligible region, a USDA loan can be an affordable way to purchase a home.
Rocket Mortgage® does not offer USDA loans at this time.
The Bottom Line On Qualifying For A Mortgage
Qualifying for a mortgage involves providing mandatory information on your finances to prove your capability to handle a mortgage. Lenders consider income, DTI, credit and assets to determine eligibility. If you don’t qualify for a mortgage with your present circumstances, you can act to strengthen your financial profile. There are also several mortgage types available from the federal government to help you qualify if your credit score or income are lower.
Understanding what you need to qualify for a mortgage can help make your dream of becoming a homeowner possible. If you’re ready to qualify for a mortgage, start the application online today.