Tips on How To Qualify For A Mortgage
Are you ready to jump from renting a home or an apartment to owning a home? To get started, you must apply for a mortgage. However, are you able to tell in advance whether or not you will qualify?
In this article, we will introduce you to some of the factors that lenders look at when considering mortgage applications and share a few tips to strengthen your application.
Qualifying For A Mortgage: The Basics
Let's start by looking at the main factors that lenders first consider when deciding whether you qualify for a mortgage. The type of property, the size of the mortgage, the amount of debt you have, your credit score , and your income play an important role in getting approved.
Your household income is one of the first things lenders consider when they review your loan application. Buying a home does not require a minimum income. However, your lender does need to verify that you have enough money coming in to cover your mortgage payment, as well as your other bills.
Additionally, keep in mind that lenders won't simply consider your salary when calculating your total income. A lender may also take into account other reliable and regular sources of income such as:
- Military benefits and allowances
- Any extra income from a side hustle
- Alimony or child support payments
- Income from investment accounts
- Social Security payments
Consistent income is essential to lenders. Typically, they won't consider a source of income unless it is likely to continue for two more years. For instance, your lender is unlikely to consider your incoming child support payments as income if they are due to expire in six months.
The type of property you are looking to buy will also affect your ability to get a loan. An easy way to buy a property is to buy a primary residence. When you purchase a primary residence, you're buying a home you plan to live in most of the time.
Primary residences are considered less risky for lenders, allowing them to extend loans to more people. For example, what happens if you lose a source of income or receive an unexpected bill? It's more likely that you'll prioritize the payments on your home. Some types of government-backed loans are valid only for purchasing a primary residence.
Suppose you want to buy a secondary property instead. Since these property types are riskier for lenders, you'll need higher credit, down payment, and debt requirements. The same applies to buying investment properties.
You must show your lender that you can continue to pay your premiums even if you run into a financial emergency. Here's where assets come in. Assets are things you own that are valuable. These include the following:
- Checking and savings accounts
- Certificates of deposit (CDs)
- Stocks, bonds, and mutual funds
- IRAs, 401(k)s, or any other retirement account you may have
These assets may require documentation, such as bank statements, to prove their authenticity.
Credit scores are three-digit numerical indicators of your reliability as a borrower. You typically have a high credit score if you pay your bills on time, don't take on too much debt, and watch your spending. If you have a low credit score, you may fall behind on payments frequently or take on more debt than you can handle. Home buyers with high credit scores have access to most loan types and the lowest interest rates.
Most types of loans require a FICO® score of at least 620 points. FHA or VA loans are ideal for people with credit scores below 620. FHA loans have lower debt, income, and credit requirements because they are government-backed.
Applicants for VA loans may include active-duty service members, members of the National Guard, reservists, and veterans. These government-backed loans require a FICO® score of 580 or higher.
The mortgage lender wants to see that you have enough income to cover all your expenses. Only looking at your income can make this difficult, so most lenders place more emphasis on your debt-to-income ratio (DTI). Lenders use your DTI ratio to determine how much of your gross monthly income goes toward required bills every month.
The debt-to-income (DTI) ratio measures how much of your gross monthly income is used to pay your monthly debt payments and is used by lenders to determine your borrowing risk.
DTI ratios are easy to calculate. The first step is to add up all the fixed payments you make each month. Include only the expenses that don't vary. For instance, you can include payments for rent, credit card minimums, and student loan payments.
Do you make monthly payments toward recurring debt? Include only the minimum amount you must pay each month. For example, if your student loans are worth $15,000 but you only need to pay $150 a month, only include $150 in your calculations. Don't include utility expenses, entertainment expenses, and health insurance premiums.
Then, divide your overall monthly expenses by your total pre-tax household income. You should include all regular and reliable income in your calculation from all sources. Calculate your DTI ratio by multiplying your number by 100.
Your DTI ratio is more attractive to lenders if it is lower than others. Most lenders will require a DTI ratio of 50% or less in order to consider approving your application.
In addition to your DTI ratio, mortgage lenders will often consider your housing expense ratio in determining your mortgage eligibility.
Other Mortgage Qualification Factors
In addition to the factors lenders take into account during the mortgage loan process, there are other things you should consider before applying. Remember to include PITI, private mortgage insurance, and closing costs when calculating the home purchase costs.
PITI stands for principal, interest, taxes, and insurance. It is a rough estimate of the amount you can afford to spend on a home. In many cases, lenders will use your PITI estimate to determine whether you qualify for a mortgage since it provides an idea of your ability to repay it. You can personally calculate your PITI if you have an idea of what you’ll owe in each category. If you do that, you can know what kind of house you can afford before you fall in love with one you cannot afford.
Private Mortgage Insurance
People often believe they cannot buy a home without at least 20% down. But it's not true at all. Depending on your loan type, you may be able to buy a home with as little as 3% down. A government-backed loan may even allow you to buy a home without any down payment. You must, however, put down at least 20% if you want to avoid paying private mortgage insurance (PMI).
The purpose of PMI is to protect your lender in case of loan default. Even though PMI does not provide you with any protections as the buyer, most mortgage lenders require you to pay it if you bring less than 20% down at closing. You can cancel your PMI once you reach 20% equity in your home by paying down your principal each month.
When applying for a mortgage, you should also consider closing costs. These are the processing fees you pay to your lender in exchange for finalizing your loan. The closing costs will vary depending on where you live and what type of mortgage you're getting. It is common for closing costs to include appraisal fees, attorney fees, and escrow fees. You can expect your closing costs to be around 2% - 6% of your loan value. Before you apply for a loan, make sure you have enough money to cover these costs.
Pre-Approval vs. Approval
A lender must provide a loan estimate within three business days of receiving a completed mortgage application. There are several sections, including information about the pre-approved loan amount, the maximum loan amount, the terms and type of mortgage, the interest rate, estimated interest and payments, estimated closing costs, and an estimate of property taxes.
An underwriter will eventually review the loan file to determine whether the borrower meets the guidelines for the specific loan program. If the buyer's financial situation has not changed since pre-approval, the buyer and lender can proceed with closing. Final loan approval occurs once the buyer obtains an appraisal for the home and the loan is applied to the property.
What is the Best Time to Get Pre-Approved for a Mortgage?
The best way to determine your maximum loan approval amount is to get pre-approved for a mortgage before you begin looking for houses. The pre-approval process also determines obstacles like excessive debt or poor credit scores.
Why Is Pre-Approval Important?
By getting pre-approved for a mortgage, a home buyer can negotiate more effectively with a seller since they already have mortgage financing and can make a reasonable offer. Otherwise, the prospective buyer would have to apply for a mortgage before making an offer and could lose out on the house.
What Is LTV Ratio?
A loan-to-value ratio (LTV) evaluates lending risk by comparing the loan value to the property's market value before approving a loan. Generally, loans with high LTV ratios are considered higher risk. Therefore, once the mortgage is approved, the loan has a higher interest rate.
The Bottom Line
The mortgage pre-approval process evaluates a home buyer's finances, and lenders require five items to ensure that borrowers will repay their loans. To obtain pre-approval, borrowers must submit a mortgage application and provide proof of assets, income, credit report, and employment verification.
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