Qualifying for a Home Loan
For most people, the first step toward home ownership is applying for a mortgage. The big questions at this stage are:
- Will I qualify?
- If so, how much mortgage money will I qualify for?
Let’s look at it from the perspective of a mortgage lender. What will they consider when reviewing your mortgage application?
Your lender wants to know if you are earning enough money to cover your monthly mortgage payments going forward. And that’s in addition to paying your other bills (credit cards, car payments, utilities, child support, and so on).
Your job salary or business revenue may not be the only consideration. Other factors that may decide if you qualify for a mortgage include investments, commissions, military benefits, and extra income from second jobs or side businesses.
The bottom line is that the lender wants to see that your income is consistent and can regularly cover your nut.
The type of property your are considering
If you are not a high earner, you may not qualify for what may be considered a luxury home. The property you are seeking should equate to the type of income and revenue you are producing.
If you are buying for the first time, your best bet is qualifying for a primary residence — a property you plan to live in yourself. Buying a secondary property, rental property or vacation home may be perceived as riskier to lenders.
In fact, certain types of mortgage loans that are backed by the government may only be valid for primary residences.
Any assets you may own
Do you have backup resources in case you lose your job or business? Lenders would be encouraged by your assets, including investments like stocks and mutual funds, IRAs, and 401(k)s. You may have to prove these assets with documentation.
Your credit score
This is a number designated to you by credit bureaus, which rates your history and ability to pay bills on time and not take on too much debt. The score usually corresponds to a mathematical calculation. This is a way to rate the risk of those seeking a mortgage without “getting personal.” It’s all based on math and nothing else.
Of course, the higher your score, the more likelihood of you being considered for a loan. A low credit score may tell the lender that you have a history of falling behind on your bill payments and/or may have too much debt to take on any more.
This credit score has a name: FICO (Fair Isaac Corporation), and most lenders consider a score of 620 to be the very least needed to qualify for most loans. If your score falls below 620, you may be eligible for a government-sponsored FHA loan.
If you’re a veteran or currently serving in the military, you could qualify for a Veterans Administration (VA) loan, which is backed by the government.
Your debt-to-income ratio
A shorter name for this is DTI. This is the percentage that shows the lender your monthly income in comparison to what you are paying on your bills.
How to calculate your DTI:
- Add up all your regular monthly debt payments (minimum payments). These should be the payments that don’t vary from month to month (like utilities, for instance). In other words, monthly fixed payments.
- Divide the sum of these payments by your total household income (pre-tax).
- Multiply that number by 100. That’s your DTI.
Other factors that could be considered when a lender is considering your qualifications for a loan:
- Closing costs (this could be 3-6% of your total loan value)
- Private mortgage insurance (PMI). If you are not able to put down 20% of the sale cost, you may be required to purchase PMI. This protects the lender if you default on your loan.
How to improve your chances for qualifying for a loan
If you feel that qualifying for a mortgage loan may be a tough road for you, consider these strategies:
- Improve your credit (pay down your debt as much as possible)
- Lower your DTI (reduce your bills/budget and increase your income)
- Save for a bigger down payment
- Consider government-backed loans (VA or FHA)
Your best bet in finding out if you qualify for a loan is to prequalify. See your loan officer, complete an application, and see where you stand before you even begin to look for a house.