Are you fed up with renting and are ready to take the plunge into buying a home? Buying your first home is an intimidating process for many people and understanding mortgage requirements come with an expensive learning curve. Doing your homework on how to qualify for a mortgage can help you avoid many of the mistakes made by first-time buyers. Here are several tips on how to qualify for a home loan that every home buyer should know before applying.
Will I Need a Down Payment?
While it is possible to buy a home without a down payment, it's a good idea to approach lenders with a down payment in hand. One of the mortgage requirements that determines your eligibility in addition to the minimum credit score for mortgage loans is your loan-to-value ratio (LTV). The more favorable the ratio of how much the property is worth to the amount you're borrowing, more qualified you become.
Best case scenario, you want to have a maximum LTV of 80 percent (or a 20 percent down payment). Lower LTVs are better and can help you qualify for a better interest rate. If you're not able to save up enough of a down payment to keep your LTV below 80 percent, you could be required to purchase private mortgage insurance even if you're not using an FHA home loan for the purchase.
How Much Home Can I Afford?
It's a good idea to determine how much home you can afford before you start looking at properties. The amount of your down payment, your income and how much debt you have determine how much house you can afford. You can use a home affordability calculator to determine your price range and even help you get prequalified from several of today's best mortgage lenders.
Preapproval vs. Prequalificaiton
When you're ready to start shopping for a home loan you're going to encounter "pre-approval" and "pre-qualification" from various lenders. What's the difference? Pre-qualification does not require your social security number and allows you to compare loan details without having your credit accessed. Pre-approval means the lender runs your credit and evaluates your finances. This is the most accurate way to shop for a home loan; however, it does require your social security number and results in a hard inquiry on your credit report.
How Much Down Payment Do I need?
Coming to the table with 20 percent is ideal; however, if you can manage 15 or even 10 percent you'll be in a much better position when it's time for closing. The more you can put down at closing, the more ownership you'll have, and the less you'll pay in financing over the lifetime of the loan.
Debt-to-Income Ratio Considerations
Mortgage lenders require that your total monthly debt including car loans, credit card bills, and student loans be no more than 36 percent of your gross monthly income. This is your debt-to-income ratio. If your ratio is too high, consider paying down high interest credit cards to get below the required limits. When planning a budget remember that your mortgage payment will likely include taxes and property insurance.
Minimum Credit Score for Mortgage Loans
Your credit score is a major factor lenders use in determining your eligibility for a home loan. Maintaining a credit score of 720 or better will earn you the most favorable mortgage rates. If your credit score is not 720 or better you can still get approved but might now qualify for today's lowest rates.
What happens if your credit score is less than 620? If you have a lower credit score and less than 20 percent for a down payment you might find lenders denying your application. This doesn't necessarily mean you can't get a mortgage, you may need to apply for with lenders that cater to borrowers in the "subprime" category. Subprime borrowers have to pay much higher interest rates and fees because there is greater risk of foreclosure for the lender.
Your Employment History Is a Consideration
Your job history is an important consideration for your ability to repay the mortgage. Borrowers who have been working at the same job for two or more years will receive more favorable consideration than someone who hops from job to job without achieving longevity. If you're self-employed or work for commission your lender may ask to see bank statements to substantiate past income history.
Arming yourself with knowledge before purchasing your first home can save you thousands of dollars from unnecessary interest and fees. Buying the perfect home is stressful enough, cutting out ambiguity will make purchasing your home much more enjoyable.