Whether it’s your first home or your dream home, house hunting can be an exciting process. However, many buyers get so caught up in finding the right house that they forget about all of the work that goes into figuring the financial aspects of purchasing a property.
At the time of publication, the average 30-year fixed-rate mortgage is 2.87%, and the average 15-year fixed-rate mortgage is 2.17%. This is great news for buyers who stand to save thousands in interest over the course of their mortgage. However, qualifying for a mortgage loan isn’t for the faint of heart.
As interest rates have dropped, the housing and mortgage market has heated up. With so many buyers trying to take advantage of favorable mortgage rates, many lenders have tightened their financing requirements.
Before you set your sights on a home, consider spending some time figuring out the type of mortgage you might qualify for, the criteria lenders look at when making financing decisions, and whether now is the right time to buy.
What Lenders Look for When Considering a Mortgage Application
Before submitting loan applications and putting your credit history through the wringer, here are a few things you’ll need to qualify for a home mortgage:
A good credit score
One of the most important factors a lender considers when deciding if they’ll approve your loan application is your credit score. Your credit score is a three-digit number that tells lenders what type of risk you pose. The higher your score, the less likely you are to default on your loan.
Credit scores range from 300 to 850 and vary based on the credit reporting agency. Your credit score is determined by the following:
- Payment history
- Credit Usage/Number of accounts
- Negative marks on your credit
- Age of credit
- Number of credit inquiries
To determine your credit score, your lender will run a credit report to see a detailed breakdown of your borrowing history. Credit reports are compiled by three distinct reporting bureaus— TransUnion, Equifax, and Experian. The bureaus collect information about your financial history including:
Credit accounts: Your payment history of all credit accounts that you currently have open will be reflected in the report. It will also show information like the type of account, the date it was opened, credit limit, loan amount, and current balance.
Credit inquiries: Your report will reflect the number of hard inquiries that have been made to your record. A hard inquiry occurs when another lending party accesses your report after you request credit. So even if you don’t actually open an account, your lender can see the attempts at obtaining credit. Keep in mind that a high number of credit inquiries can negatively impact your credit score.
Collections and public records: If you’ve ever filed for bankruptcy or have had debts turned over to collections, this will be reflected in a credit report. Information is also compiled from state and county-level courts.
The credit score you need to qualify for a mortgage loan depends on the type of loan you’re seeking. The scores listed below are estimates, but you should aim to have a score of at least the minimum listed before you submit loan applications.
- FHA/USDA loan: 580
- VA loan: 580
- Conventional loan: 620
- Jumbo loan: 680
Each lender may have additional requirements based on your credit score, income, or credit history.
If you need to raise your credit score, the most important thing you can do is pay your bills on time. Your payments make up 35% of your total score. Late payments and collection accounts can cause your score to drop by 100 points or more.
Proof of reliable income
Before approving your mortgage loan, a lender wants to know that you’re able to make monthly payments. They’ll ask you to provide some or all the following documents as verification of your income:
- Tax returns for the past two years
- Up to 12 months of pay stubs
- Investment account documents
- Bank account information
- Self-employment income
- Gift statements
Borrowers who work a traditional job with W-2 income should be able to provide proof of income quickly. Those who are self employed may have to provide additional documentation to verify their earnings. If your primary source of income is from your own business, be prepared to provide a mortgage lender with some or all the following documents:
- Two years of personal tax returns
- Two years of business tax returns
- Business license
- Profit and Loss statement
- Balance Sheets
- Letter from a CPA stating that you are still in business
To lessen the risk of a borrower defaulting on a loan, lenders want to see proof of consistent income. Monthly income that fluctuates dramatically could make it harder to obtain a mortgage. At the very least, you’ll need to provide additional tax returns, sometimes up to 5-years’ worth.
When considering fluctuating income from self-employment, lenders will typically average the total amount earned over the total number of years you’ve been in business. For example, if you earned $50,000 in the first year, $40,000 the second year, and $75,000 the third year, the lender would add up the three totals and divide it by three. This would put your qualifying income at $55,000.
If you’re not using your self-employment income to qualify, you don’t need to include the information on your loan.
Another factor that lenders also look at is the debt-to-income (DTI) ratio, which is a number that compares your monthly gross income to your total debt payment. While lenders want to see that you have money coming in, they also want to check that it’s not all going out to pay for other bills and loans you may have. Generally speaking, the highest DTI that a lender will allow is 43%, but most prefer to less than 36%.
Proof of assets
Lenders may also consider your assets like savings accounts, checking accounts, and investments when compiling your risk profile. Even if you have a solid income, it’s also important to have some funds available for emergencies. Should you ever face something like job loss or hefty medical expenses, some money in the bank would allow you to make your monthly mortgage payments without relying on your monthly income.
A solid down payment
Your lender will also consider how much you have saved for your down payment. If your credit score is less than ideal, or your income fluctuates heavily, a down payment of 20% or more could make it easier to qualify. For home buyers who are struggling to scrape together enough a down payment, state and federal down payment assistance programs may be an option.
Some mortgage loans (like a VA loan) don’t require a down payment, while others offer a down payment requirement as low as 3.5%. You’ll need to talk to your lender about how much of a down payment you’ll need for your loan.
If you put less than 20% towards the down payment, you may be on the hook for private mortgage insurance (PMI), which can tack on an additional .58% to 1.86% of the original loan amount each year.
Also keep in mind that a down payment isn’t the only money you pay upfront to buy a house. When determining whether you have saved enough to buy, you will also need to factor in other closing costs like homeowner’s insurance and initial property taxes. For buyers, these can run upwards of 5-6% of the home’s total purchase price.
Reliable renter’s history
If this is your first home purchase or you don’t have a long credit history, you may need to provide a renter’s history. This will show whether or not you’ve been consistent with your housing payments.
Documentation of gifts
You may have some generous family or friends that decide to help you out with the purchase of your home. However, a sudden influx of money to your bank account may look like a loan to a lender, which can affect whether or not you’ll be approved for the loan.
If you’ve been gifted money to use towards a down payment, you might need to include a letter from the donor that states that the money is, in fact, a gift that comes with no expectation of repayment. A letter gift typically includes:
- The donor’s information such as name, address, and phone number
- Relationship to the gift recipient
- The amount and date of the gift
- A statement that the gift need not be repaid
- Signature of the donor
What could derail your loan?
Purchasing a home is a substantial financial commitment. You’ll need to do some careful planning to ensure that your finances stay on track, especially once you begin the application process. A few things that could cause problems with your mortgage loan include:
New credit card spending
Your debt-to-income ratio makes up a significant part of your credit score, as does the age of your accounts. Therefore, it’s best not to charge anything major to your credit cards for a few weeks before you begin applying for a mortgage. Don’t, for example, take out a line of credit to buy furniture or purchase a new car. The same goes for after you’ve submitted your home loan application. A shopping spree leading up to a home purchase could signal unwanted risk to a potential lender.
Leaning too heavily on your credit cards during the home loan application process could, at best, delay financing while the underwriter investigates the sudden uptick in spending. In some cases, the lender could withdraw their mortgage approval altogether. Therefore, it’s best to avoid opening new credit cards or making major purchases until after you close.
If you lose your job, you could also lose your loan approval. However, if you do suffer a job loss, you should notify your lender immediately. You still may be able to continue with your application if you are able to find another job quickly; however, you should expect some hiccups and delays in processing.
A low property appraisal
Before making an offer on a home, your real estate agent should provide you with a comparative market analysis and recommend a suggested price range based on the fair market value of the home. While the housing market is very competitive, your lender can refuse to fund the purchase if you make an offer that’s too high above the appraisal value. Most lenders (especially with FHA loans) won’t let you borrow more than a property is worth. If you are willing to pay more for a home you love, you can usually offset the risk to the lender by paying the difference between the appraisal value and purchase price out of pocket. However, it’s best to have an accurate understanding of a home’s current value before going in with your offer.
How Can REX Help You Finance Your Home Purchase?
When you’re ready to find the right lender for your home purchase, REX Home Loans is here for you. We offer low fees, fast pre-approval, and a range of loan options to help you find the most competitive rates.
When you work with REX, you work with a team that has your best interest at heart. Because our agents and loan officers don’t work on commission, their focus stays on finding the solution that’s best for you. They are also able to pass on savings that traditional brokerages cannot.
Getting a mortgage doesn’t have to be painful. With REX, you’ll deal with friendly professionals that want to help you every step of the way. We’ll even offer cash back savings to put you in a better position for the future.
Call us today to find out how REX can help you find and fund the home of your dreams.